Alternative Banking and Recovery from Crisis

Alternative Banking and Recovery from Crisis

Kurt Mettenheim

Paper to be presented to the Progressive Economy Forum


Kurt Mettenheim & Olivier Butzbach


5-7 March 2014, Brussels


Alternative Banking and Recovery

Abstract This paper examines the unexpected back to the future modernization of social and public banking across Europe since 2000 provide policy options to recover from crises, sustain ssustainable development. Recent research and international and domestic policy making debates have begun to recognizebanks, cooperative banks and special purpose baignored by a policy consensus on the virtues of privatization and liberalization and scorned by most economists as inefficient banksinvestment banks acting as directliberalization of banking and monetary union in Europe,privatized or demutualized, have realized competitive advantages to sustain market share and modernize while seeking to recast their social missions and policy mandates for the 21century. The paper will report statistical evidence from BANKSCOPEbank change, and comparative case studies to clarify competitive advantage and of alternative banks since 2000of this back to the future modernization of social and public banking for policy debates and strategies for recovery from crisis in Europe and abroad. Kurt Mettenheim Social and Legal Sciences DepartmentSão Paulo Business School Escola de Administração de Empresas de São Paulo, Fundação Getulio Vargas (FGV-EAESP)Av 9 de Julho 2029 01313-902 São Paulo, SP, Brazil +55 11 3799 7858 / 7805 with [email protected] www.fgv.academia.edu/kurtvonmettenheimwww.pickeringchatto.com/brazil

Acknowledgments Support for research came fromresearch fund of the Fundação GetulioFoundation, for a conference on alternative banking and social inclusion at the Bellagio Center in July 2011 and research residencies for the meetings of the Society for the A(2012) and Milan (2013).


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the unexpected back to the future modernization of social and public since 2000 and explores how alternative banking institutions may

provide policy options to recover from crises, sustain social inclusion and accelerate sustainable development. Recent research and international and domestic policy making

tes have begun to recognize the important role of non-joint stock banks such as savings banks, cooperative banks and special purpose banks. For decades, these institutions

onsensus on the virtues of privatization and liberalization and scorned by fficient banks doomed to be replaced by private commercial and

investment banks acting as direct intermediaries in capital markets. To the contrary, since liberalization of banking and monetary union in Europe, alternative banks, where not privatized or demutualized, have realized competitive advantages to sustain market share and

king to recast their social missions and policy mandates for the 21report statistical evidence from BANKSCOPE, other data sources

bank change, and comparative case studies to clarify the institutional foundations of alternative banks since 2000. We also explore the implications

back to the future modernization of social and public banking for banking theory, policy debates and strategies for recovery from crisis in Europe and abroad.

Olivier Butzbach Social and Legal Sciences Department King's College London

Department of Management de Administração de Empresas de São Paulo, Franklin-Wilkins Building

EAESP) 150 Stamford Street SE1 9NH London United Kingdom

+55 11 3799 7858 / 7805 with Sandra [email protected]

www.fgv.academia.edu/kurtvonmettenheim www.pickeringchatto.com/alternat

m: The Second University of Naples, Italy; GGetulio Vargas Sao Paulo Business School;

on alternative banking and social inclusion at the Bellagio Center research residencies for the authors. We also thank fellowociety for the Advancement of Socio-Economics, in Paris


the unexpected back to the future modernization of social and public and explores how alternative banking institutions may

ocial inclusion and accelerate sustainable development. Recent research and international and domestic policy making

joint stock banks such as savings nks. For decades, these institutions were

onsensus on the virtues of privatization and liberalization and scorned by doomed to be replaced by private commercial and

intermediaries in capital markets. To the contrary, since alternative banks, where not

privatized or demutualized, have realized competitive advantages to sustain market share and king to recast their social missions and policy mandates for the 21st

other data sources on the institutional foundations of

explore the implications banking theory,

policy debates and strategies for recovery from crisis in Europe and abroad.

www.pickeringchatto.com/alternative

GVpesquisa, the and the Rockefeller

on alternative banking and social inclusion at the Bellagio Center We also thank fellow participants at

in Paris (2009), Boston

Executive Summary Introduction 1 Defining and differentiating alternative banks 2 Alternative bank histories

2.1. Italy 2.2. Germany 2.3 Postal Savings Banks

3 Alternative banks after liberalization, deregulation, privatizations and IT revolution

3.1 Back to the future of alternative banking 4 Why alternative banks matter

4.1 Institutions for social and economic development4.2 Alternative banks buffer systemic stability

5 Explaining competitive advantages of alternative banks with banking theory

5.1 Alternative banking and agency theory5.2 Managers-shareholders agency conflicts5.3 Other agency conflicts

6 Alternative banks mitigate information asymmetries through relationship banking 7 Alternative bank funding, equity, reserves and patrimony 8 The sustainable business models of alternative banks 9 Alternative banks smooth inter 10 Conclusion References Appendices


3

Table of Contents

1 Defining and differentiating alternative banks

ostal Savings Banks

Alternative banks after liberalization, deregulation, privatizations and IT revolutione future of alternative banking

Why alternative banks matter .1 Institutions for social and economic development .2 Alternative banks buffer systemic stability

5 Explaining competitive advantages of alternative banks with banking theory5.1 Alternative banking and agency theory

shareholders agency conflicts 5.3 Other agency conflicts

information asymmetries through relationship banking

7 Alternative bank funding, equity, reserves and patrimony

8 The sustainable business models of alternative banks

9 Alternative banks smooth inter-temporal risk


page 4

5

7

8 9 10 14

Alternative banks after liberalization, deregulation, privatizations and IT revolution 15 16

18 19 19

5 Explaining competitive advantages of alternative banks with banking theory 20 22 23 27

information asymmetries through relationship banking 30

32

33

34

35

37

49

Executive Summary Unlike business models of private banks based on profit maximization, shareholder governance and executive-centered management, alternative banks (such as cooperative banks, government savings banks and special purpose banks), share busion sustained returns for long-term horizons; corporate missions that include social and public policy goals; and stakeholder-oriented, boardrecent research suggests that alternative banks have ebanks in terms of efficiency, profitability and risk management. This counters core ideas in contemporary banking theory and bank regulation about the superiority of private, marketbased banking. Concepts and theories frbanks outperform private banks in terms of deposits, reducing information asymmetries, and ameliorating agency conflicts. However, heterodox theories of the firm and institutional foundations of competitive advantage further clarify the historical, social, and organizational advantages (and risks) of alternative banks. Recent research on alternative banksEurope and beyond. First, on a systemic level, alternative banks matter. Compared to banking systems that rely almost exclusively on private commercial and investment banking, the more traditional and socially oriented business models of alternative banks help aand crises caused by the excesses of profit maximizing private banks. Second, alternative banks increase diversity in banking systems. Recent debates among policy-makers and academics emphasize the This warrants a whole chapter in work by academics long interested in nonin policy debates, Andrew Haldane. While agreement has emerand the need to encourage it in banking systems, few ideas have emerged about how toabout this, mostly because of the pgovernment persists in believing they can cThis paper explores how diversehistory and persisted through the most variedcompetitors. This suggests that more than liberalization is needed. banks and "biodiversity" in banking banks through specific regulation

On the level of policy opportunities, tof alternative banks in the 21st century social forces. Local and regional savings banks (and their shared wholesale groups) help citizens and small and medium enterprises secure access to banking and credit that otherwise would suffer financial exclusion and credit rationing. Cooperative banks embedded in local and regional socisocial, regional and cultural missions at the heart of corporate identities and governance.

Special purpose banks provide powerful comparative advantagebecause, as banks, these institutions multiply official deposits by tw(rounding Basel capital reserve requirements)many European governments amidst crisis. Special purpose banks also increase public control over policy implementation through contrtransparent overview from regulatory authorities, the media and press and public.

Biases in favor of private banking have blinded Europeans from using their longstanding, large alternative banking groups to recover


4

Unlike business models of private banks based on profit maximization, shareholder centered management, alternative banks (such as cooperative

banks, government savings banks and special purpose banks), share business models based term horizons; corporate missions that include social and public oriented, board-centered governance. Strong evidence from

recent research suggests that alternative banks have equaled or outperformed jointbanks in terms of efficiency, profitability and risk management. This counters core ideas in contemporary banking theory and bank regulation about the superiority of private, marketbased banking. Concepts and theories from banking studies help explain how alternative banks outperform private banks in terms of core functions such as creating liquidity, pooling deposits, reducing information asymmetries, and ameliorating agency conflicts. However,

firm and institutional foundations of competitive advantage further clarify the historical, social, and organizational advantages (and risks) of alternative banks.

lternative banks provides new ideas for responses to crisis in First, on a systemic level, alternative banks matter. Compared to banking

systems that rely almost exclusively on private commercial and investment banking, the more traditional and socially oriented business models of alternative banks help aand crises caused by the excesses of profit maximizing private banks.

Second, alternative banks increase diversity in banking systems. Recent debates among makers and academics emphasize the need for diversity or heterogeneity

This warrants a whole chapter in the recent EU ‘Liikanen’ report and is the focus of recent work by academics long interested in non-profit, such as David Lewellyn and a leading figure in policy debates, Andrew Haldane. While agreement has emerged about the value of diversity and the need to encourage it in banking systems, few ideas have emerged about how toabout this, mostly because of the persistence of biases toward market-based

persists in believing they can create diversity by decreasing barriers how diverse types of alternative banks emerged very

through the most varied contexts since, often outperformsts that more than liberalization is needed. The benefits of

in banking require public policies to protect and nurture through specific regulations, tax incentives, and other rules.

icy opportunities, the unexpected back to the future modernization century provides critical policy alternatives for political and

social forces. Local and regional savings banks (and their shared wholesale groups) help izens and small and medium enterprises secure access to banking and credit that otherwise

would suffer financial exclusion and credit rationing. Cooperative banks also remain embedded in local and regional social institutions, specializing in relationship

missions at the heart of corporate identities and governance. Special purpose banks provide powerful comparative advantages for public policy

because, as banks, these institutions multiply official deposits by two and capitalization by ten(rounding Basel capital reserve requirements). This is critical given the fiscal constraints of many European governments amidst crisis. Special purpose banks also increase public control over policy implementation through contractual monitoring and supervision amidst transparent overview from regulatory authorities, the media and press and public.

Biases in favor of private banking have blinded Europeans from using their longstanding, large alternative banking groups to recover from crisis.


Unlike business models of private banks based on profit maximization, shareholder centered management, alternative banks (such as cooperative

ness models based term horizons; corporate missions that include social and public

centered governance. Strong evidence from qualed or outperformed joint-stock

banks in terms of efficiency, profitability and risk management. This counters core ideas in contemporary banking theory and bank regulation about the superiority of private, market-

om banking studies help explain how alternative core functions such as creating liquidity, pooling

deposits, reducing information asymmetries, and ameliorating agency conflicts. However, firm and institutional foundations of competitive advantage further

clarify the historical, social, and organizational advantages (and risks) of alternative banks. responses to crisis in

First, on a systemic level, alternative banks matter. Compared to banking systems that rely almost exclusively on private commercial and investment banking, the more traditional and socially oriented business models of alternative banks help avert asset bubbles

Second, alternative banks increase diversity in banking systems. Recent debates among diversity or heterogeneity in banking.

report and is the focus of recent profit, such as David Lewellyn and a leading figure

ged about the value of diversity and the need to encourage it in banking systems, few ideas have emerged about how to go

based banking (the UK reate diversity by decreasing barriers to entry).

very early in European outperforming for-profit he benefits of alternative

protect and nurture alternative

back to the future modernization policy alternatives for political and

social forces. Local and regional savings banks (and their shared wholesale groups) help izens and small and medium enterprises secure access to banking and credit that otherwise

also remain , specializing in relationship banking with

missions at the heart of corporate identities and governance. for public policy

o and capitalization by ten . This is critical given the fiscal constraints of

many European governments amidst crisis. Special purpose banks also increase public control actual monitoring and supervision amidst

transparent overview from regulatory authorities, the media and press and public. Biases in favor of private banking have blinded Europeans from using their

Introduction

Explanations of the 2007-8 financial crisis (Lo, 2012) and positions in debates about how to regulate banks in its wake rely on implicit or explicit normative assumptions about the business models of banks. Banks used to be seeinstitutions (Allen and Santomero, 2001). However, since contemporary banking theory favours disintermediation in the sense of banks using products and services traded on financial markets credit, and manufacture assets (Berger (2013) review how strategies of marketprolonged recover, while De Jonghe (2010) and Gorton and Metrick (2010) have called for a return to narrow banking (traditional depositregulations to separate investment banking from retail banking such as US, or ring-fencing (UK Independent Commission on Banking, 2011), have, to date, been watered down through compromises with marketappear unable to reverse the trend toward capital market operations in large private banks.Remarkably, both academic research and policy proposals have largely overlooked alternative bank groups, large and small, that avoided the excessive risks and capital marketmaximizing business models blamed for crisis in 2007(Butzbach and Mettenheim, 2014) includes a wide variety of credit institutions such as cooperative banks and credit unions, government savings banks and special purpose (development) banks, building societies, thrifts and mutual savings bconcept of alternative banking is justified because these institutions differ from private banks and share business models based on the following: 1) an absence of profit maximization imperatives and shareholder based governance; returns; 3) business missions that include social and public goods and; 4) stakeholder oriented, board-centered governance.

Several European alternative bank groups strayed from these principles. In Spain, the Cajas (savings banks) helped drive the boom and bust cycle that has devastated the country. In Germany, several Landesbanken global investment banks during the 2000s only to be caught in the 2007Raiffeisen cooperative bank group expanded investment banking and commercial banking operations across Eastern and Central Europe after the collapse of the Soviet Union only to retreat after the recent crisis. In the UK, aggressive growth strategiCoop Bank. Government banks in developing and emerging countries have long drawn criticism for crony credit, poor management and environmental damage. However, many government owned savings banks and development banks in these cofrom capture and mismanagement under military rule and authoritarian regimes to shape growth amidst democratization and reforms, provide counterafter 2008 and, perhaps most importantly, bring vastinto the formal economy while providing new social policies such as basic income (Mettenheim et al, 2013).

The specific experiences of alternative banks vary. However, this article builds on the growing empirical literature that finds alternative banks equal to or superior than jointcompetitors in terms of efficiency, profitability, risk management and other standard criteria used in banking studies. These findings hold in a variety of settings, most ironicallyears after liberalization, deregulation, privatizations and foreign bank entry. Instead of


5

8 financial crisis (Lo, 2012) and positions in debates about how to regulate banks in its wake rely on implicit or explicit normative assumptions about the business models of banks. Banks used to be seen as deposit-taking and loaninstitutions (Allen and Santomero, 2001). However, since Battacharya and Thakor (1993), contemporary banking theory favours disintermediation in the sense of banks using products and services traded on financial markets to manage risk, price assets and liabilities, allocate credit, and manufacture assets (Berger et al, 2010). Contributors to Hardie and Howarth (2013) review how strategies of market-based banking caused financial crisis and have

e Jonghe (2010) and Gorton and Metrick (2010) have called for a return to narrow banking (traditional deposit-taking and loan-making). Proposals for regulations to separate investment banking from retail banking such as the Volcker rule in the

fencing (UK Independent Commission on Banking, 2011), have, to date, been watered down through compromises with market-based views of banking (Lall, 2012) and appear unable to reverse the trend toward capital market operations in large private banks.

rkably, both academic research and policy proposals have largely overlooked alternative bank groups, large and small, that avoided the excessive risks and capital marketmaximizing business models blamed for crisis in 2007-8. The category of (Butzbach and Mettenheim, 2014) includes a wide variety of credit institutions such as cooperative banks and credit unions, government savings banks and special purpose (development) banks, building societies, thrifts and mutual savings banks. However, a broad concept of alternative banking is justified because these institutions differ from private banks and share business models based on the following: 1) an absence of profit maximization

shareholder based governance; 2) long-term business horizons sustained by returns; 3) business missions that include social and public goods and; 4) stakeholder

centered governance. Several European alternative bank groups strayed from these principles. In Spain, the

(savings banks) helped drive the boom and bust cycle that has devastated the country. Landesbanken (provincial government banks) attempted to become

global investment banks during the 2000s only to be caught in the 2007-8 crisis. The Raiffeisen cooperative bank group expanded investment banking and commercial banking operations across Eastern and Central Europe after the collapse of the Soviet Union only to retreat after the recent crisis. In the UK, aggressive growth strategies led to reversals at the

Government banks in developing and emerging countries have long drawn criticism for crony credit, poor management and environmental damage. However, many government owned savings banks and development banks in these countries have recovered from capture and mismanagement under military rule and authoritarian regimes to shape growth amidst democratization and reforms, provide counter-cyclical credit to adjust to crisis after 2008 and, perhaps most importantly, bring vast numbers of previously bankless citizens into the formal economy while providing new social policies such as basic income

The specific experiences of alternative banks vary. However, this article builds on the terature that finds alternative banks equal to or superior than joint

competitors in terms of efficiency, profitability, risk management and other standard criteria used in banking studies. These findings hold in a variety of settings, most ironicall

liberalization, deregulation, privatizations and foreign bank entry. Instead of


8 financial crisis (Lo, 2012) and positions in debates about how to regulate banks in its wake rely on implicit or explicit normative assumptions about the

taking and loan-making Battacharya and Thakor (1993),

contemporary banking theory favours disintermediation in the sense of banks using products to manage risk, price assets and liabilities, allocate

, 2010). Contributors to Hardie and Howarth based banking caused financial crisis and have

e Jonghe (2010) and Gorton and Metrick (2010) have called for a making). Proposals for

the Volcker rule in the fencing (UK Independent Commission on Banking, 2011), have, to date, been

based views of banking (Lall, 2012) and appear unable to reverse the trend toward capital market operations in large private banks.

rkably, both academic research and policy proposals have largely overlooked alternative bank groups, large and small, that avoided the excessive risks and capital market-based, profit

8. The category of alternative banks (Butzbach and Mettenheim, 2014) includes a wide variety of credit institutions such as cooperative banks and credit unions, government savings banks and special purpose

anks. However, a broad concept of alternative banking is justified because these institutions differ from private banks and share business models based on the following: 1) an absence of profit maximization

term business horizons sustained by returns; 3) business missions that include social and public goods and; 4) stakeholder

Several European alternative bank groups strayed from these principles. In Spain, the (savings banks) helped drive the boom and bust cycle that has devastated the country.

(provincial government banks) attempted to become 8 crisis. The Austrian

Raiffeisen cooperative bank group expanded investment banking and commercial banking operations across Eastern and Central Europe after the collapse of the Soviet Union only to

es led to reversals at the Government banks in developing and emerging countries have long drawn

criticism for crony credit, poor management and environmental damage. However, many untries have recovered

from capture and mismanagement under military rule and authoritarian regimes to shape cyclical credit to adjust to crisis

numbers of previously bankless citizens into the formal economy while providing new social policies such as basic income

The specific experiences of alternative banks vary. However, this article builds on the terature that finds alternative banks equal to or superior than joint-stock

competitors in terms of efficiency, profitability, risk management and other standard criteria used in banking studies. These findings hold in a variety of settings, most ironically many

liberalization, deregulation, privatizations and foreign bank entry. Instead of

convergence toward joint-stock private banking, alternative banks have modernized to maintain or expand market shares. We explain this anomaly for neoapproaches and neo-liberal policy designs by focusing on the main features of savings banks, cooperative banks and government special purpose banks. Explanations of alternative bank performance are drawn from banking theory and heterodox reseabanking theory reveal how alternative banks perform the core functions of modern banks such as creating liquidity, pooling deposits, reducing information asymmetries and managing potential agency conflicts. Heterodox theories orevealing further institutional foundations of competitive advantages in alternative banking.Since the 2007-8 financial crisis, a wide variety of scholars and policythe risky business models of private commercial and investment banks (US Government Financial Crisis Inquiry Commission, 2011; Admati and Hellwig, 2013). Although still marginal to policy debates and research in the mainstream disciplines of accounting, political economy, and law, the errors of private banks have nonetheless begun to produce reassessment of alternative banks (Butzbach and Mettenheim, 2014) and raise concern about the lack of organizational diversity in banking Goodhart and Wagner, 2012; Ayadi reassessment pales in comparison to decades of research biased toward private and jointstock banks and policy reforms that sought to reduce or eliminate government and nonbanks and credit institutions through privatizations, demutualization, liberalization, foreign bank entry and deregulation of credit markets.

The bulk of mainstream economists and personnel at international policy making institutions expected alternative banks to disappear, either sooner through privatizations or later as liberalization revealed the greater efficiency of private and foreign banks; or indeed after alternative bank managers would abandon longstanding traditions of social and state banking in favour of profit maximizing, marketcommercial and investment banks. The contrary has ensued. banking groups have, through a variety of strategies, modernized to hold their gmaintaining or gaining market shares in many advanced and developing countries, especially in retail banking (deposits, savings accounts and lending to small and medium enterprises and households). And empirical studies have gone beyond descriptiveshares to show how alternative banks have in many cases equaled or exceeded the performance of private banks in terms of cost, operational efficiency and profitability.

This is a paradox. As Canning et al. put it, “a central issue isarise and survive in a world dominated by investorMost banking studies simply ignore alternative banks. The aim of this paper is, therefore, to propose a consistent framework to explain The paper is organized as follows. Section one defines and differentiates alternative banks from private banks. Section two illustrates histories of alternative banks to introduce their institutional foundations of competitive advantage. Section three explores why alternative banks matter for social and economic development and systemic stability of banking. Section four explores the unexpected realization of competitive advantages by alternative banks afterliberalization, deregulation, privatizations and the revolution in technologies of information and communication that have changed the industry. Section five draws from theories of agency conflicts in banking studies to explain the competitive advantages Section six explores how stakeholder governance embedded in local, regional and national social and political forces mitigate information asymmetries through relationship banking. Section seven briefly explores how alternative banks o


6

stock private banking, alternative banks have modernized to maintain or expand market shares. We explain this anomaly for neo-classi

liberal policy designs by focusing on the main features of savings banks, cooperative banks and government special purpose banks. Explanations of alternative bank performance are drawn from banking theory and heterodox research on firms. Concepts from banking theory reveal how alternative banks perform the core functions of modern banks such as creating liquidity, pooling deposits, reducing information asymmetries and managing

Heterodox theories of the firm expand the scope of analysis by revealing further institutional foundations of competitive advantages in alternative banking.

8 financial crisis, a wide variety of scholars and policy-makers have criticized ls of private commercial and investment banks (US Government

Financial Crisis Inquiry Commission, 2011; Admati and Hellwig, 2013). Although still marginal to policy debates and research in the mainstream disciplines of accounting, political

aw, the errors of private banks have nonetheless begun to produce reassessment of alternative banks (Butzbach and Mettenheim, 2014) and raise concern about the lack of organizational diversity in banking (Michie and Oughton, 2013; Liikanen, 2012;

and Wagner, 2012; Ayadi et al, 2010; Ayadi et al, 2009). However, this belated reassessment pales in comparison to decades of research biased toward private and jointstock banks and policy reforms that sought to reduce or eliminate government and nonbanks and credit institutions through privatizations, demutualization, liberalization, foreign

deregulation of credit markets. The bulk of mainstream economists and personnel at international policy making

ative banks to disappear, either sooner through privatizations or later as liberalization revealed the greater efficiency of private and foreign banks; or indeed after alternative bank managers would abandon longstanding traditions of social and state

ing in favour of profit maximizing, market-based business models taken from private commercial and investment banks. The contrary has ensued. Defying expectations, alternative banking groups have, through a variety of strategies, modernized to hold their gmaintaining or gaining market shares in many advanced and developing countries, especially in retail banking (deposits, savings accounts and lending to small and medium enterprises and households). And empirical studies have gone beyond descriptive evidence from market shares to show how alternative banks have in many cases equaled or exceeded the performance of private banks in terms of cost, operational efficiency and profitability.

As Canning et al. put it, “a central issue is why notarise and survive in a world dominated by investor-owned banks, run for profit” (2003: 244). Most banking studies simply ignore alternative banks. The aim of this paper is, therefore, to propose a consistent framework to explain this unexpected persistence of alternative banks.The paper is organized as follows. Section one defines and differentiates alternative banks from private banks. Section two illustrates histories of alternative banks to introduce their

tions of competitive advantage. Section three explores why alternative banks matter for social and economic development and systemic stability of banking. Section four explores the unexpected realization of competitive advantages by alternative banks afterliberalization, deregulation, privatizations and the revolution in technologies of information and communication that have changed the industry. Section five draws from theories of agency conflicts in banking studies to explain the competitive advantages Section six explores how stakeholder governance embedded in local, regional and national social and political forces mitigate information asymmetries through relationship banking. Section seven briefly explores how alternative banks obtain funding and hold equity, reserves


stock private banking, alternative banks have modernized to classical economic

liberal policy designs by focusing on the main features of savings banks, cooperative banks and government special purpose banks. Explanations of alternative bank

rch on firms. Concepts from banking theory reveal how alternative banks perform the core functions of modern banks such as creating liquidity, pooling deposits, reducing information asymmetries and managing

f the firm expand the scope of analysis by revealing further institutional foundations of competitive advantages in alternative banking.

makers have criticized ls of private commercial and investment banks (US Government

Financial Crisis Inquiry Commission, 2011; Admati and Hellwig, 2013). Although still marginal to policy debates and research in the mainstream disciplines of accounting, political

aw, the errors of private banks have nonetheless begun to produce reassessment of alternative banks (Butzbach and Mettenheim, 2014) and raise concern about

(Michie and Oughton, 2013; Liikanen, 2012; However, this belated

reassessment pales in comparison to decades of research biased toward private and joint-stock banks and policy reforms that sought to reduce or eliminate government and non-profit banks and credit institutions through privatizations, demutualization, liberalization, foreign

The bulk of mainstream economists and personnel at international policy making ative banks to disappear, either sooner through privatizations or

later as liberalization revealed the greater efficiency of private and foreign banks; or indeed after alternative bank managers would abandon longstanding traditions of social and state

based business models taken from private Defying expectations, alternative

banking groups have, through a variety of strategies, modernized to hold their ground - maintaining or gaining market shares in many advanced and developing countries, especially in retail banking (deposits, savings accounts and lending to small and medium enterprises

evidence from market shares to show how alternative banks have in many cases equaled or exceeded the performance of private banks in terms of cost, operational efficiency and profitability.

why not-for-profit banks owned banks, run for profit” (2003: 244).

Most banking studies simply ignore alternative banks. The aim of this paper is, therefore, to this unexpected persistence of alternative banks.

The paper is organized as follows. Section one defines and differentiates alternative banks from private banks. Section two illustrates histories of alternative banks to introduce their

tions of competitive advantage. Section three explores why alternative banks matter for social and economic development and systemic stability of banking. Section four explores the unexpected realization of competitive advantages by alternative banks after liberalization, deregulation, privatizations and the revolution in technologies of information and communication that have changed the industry. Section five draws from theories of agency conflicts in banking studies to explain the competitive advantages of alternative banks. Section six explores how stakeholder governance embedded in local, regional and national social and political forces mitigate information asymmetries through relationship banking.

btain funding and hold equity, reserves

and patrimony differently than private banks. Section eight summarizes the sustainable business models of alternative banks, while section nine reviews recent research suggesting that alternative banks may smooth intfindings and argues for extending the scope of banking studies through further analysis of alternative banks and research on the institutional foundations of competitive advantage in banking.

1) Defining and differentiating alternative banks

The concept of alternative banks encompasses a broad, heterogeneous set of financial institutions including cooperative banks and savings banks, credit unions, mutual savings associations, government development bankmay appear to have little in common. How can we compare, for instance, small British building societies or local (sometimes “single window”) Italian cooperative banks with a financial Behemoth such as the Netdifferences, alternative banks share three core characteristics that differ from what is often seen as the typical bank in academic research and policy making debates: the jointprofit universal bank. The three core characteristics of alternative banks are:

Corporate Purpose: Alternative banks are notshareholder value or returns for owners. This does not mean that alternative banks do not make profits: they do, and have been found to be However, the corporate missions of alternative banks retain a broad range of explicitly stated objectives, to be sustained by returns, such as favoring economic and sociafinancing local projects, making credit available to poorer households or small businesses, and providing long term investments in social and cultural capital and public policies.

Governance Structure: The governance of alternative banks isboard-centered in the sense that they: (a) are not run for the exclusive benefit of shareholders; (b) are controlled by a broader range of stakeholders than for(members in the case of mutuals, credit unions and cooprepresentatives (and often clients) in the case of savings banks, and regional or national governments in the case of special purpose or development banks, and; (c) are managed by corporate boards that keep executives and staff under joint-stock banks.

Business Models: The business models of alternative banks differ from private bank business models along two crucial dimensions: (a) more cautious, longsustain social and public policy missions through returns, and; (b) corporate cultures and missions that value the social, cultural and developmental needs of their geographic areas or functionally defined members and clients.

Table 1 on the following pagethree core features for three types of alternative banks, in addition to for


7

and patrimony differently than private banks. Section eight summarizes the sustainable business models of alternative banks, while section nine reviews recent research suggesting that alternative banks may smooth inter-temporal risk. The conclusion synthesizes recent findings and argues for extending the scope of banking studies through further analysis of alternative banks and research on the institutional foundations of competitive advantage in

and differentiating alternative banks

The concept of alternative banks encompasses a broad, heterogeneous set of financial institutions including cooperative banks and savings banks, credit unions, mutual savings associations, government development banks and special purpose banks. These institutions may appear to have little in common. How can we compare, for instance, small British building societies or local (sometimes “single window”) Italian cooperative banks with a financial Behemoth such as the Netherland Rabobank, or French Crédit Agricole? Despite their differences, alternative banks share three core characteristics that differ from what is often seen as the typical bank in academic research and policy making debates: the joint

niversal bank. The three core characteristics of alternative banks are:

: Alternative banks are not-for-profit, i.e. they do not aim to maximize shareholder value or returns for owners. This does not mean that alternative banks do not

they do, and have been found to be more profitable than for-However, the corporate missions of alternative banks retain a broad range of explicitly stated objectives, to be sustained by returns, such as favoring economic and sociafinancing local projects, making credit available to poorer households or small businesses, and providing long term investments in social and cultural capital and public policies.

: The governance of alternative banks is stakeholdercentered in the sense that they: (a) are not run for the exclusive benefit of

(b) are controlled by a broader range of stakeholders than for(members in the case of mutuals, credit unions and cooperatives), government representatives (and often clients) in the case of savings banks, and regional or national governments in the case of special purpose or development banks, and; (c) are managed by corporate boards that keep executives and staff under closer supervision and control than

: The business models of alternative banks differ from private bank business models along two crucial dimensions: (a) more cautious, long-term oriented strategies to

public policy missions through returns, and; (b) corporate cultures and missions that value the social, cultural and developmental needs of their geographic areas or functionally defined members and clients.

on the following page summarizes the specificities presented by each of these three core features for three types of alternative banks, in addition to for-


and patrimony differently than private banks. Section eight summarizes the sustainable business models of alternative banks, while section nine reviews recent research suggesting

temporal risk. The conclusion synthesizes recent findings and argues for extending the scope of banking studies through further analysis of alternative banks and research on the institutional foundations of competitive advantage in

The concept of alternative banks encompasses a broad, heterogeneous set of financial institutions including cooperative banks and savings banks, credit unions, mutual savings

s and special purpose banks. These institutions may appear to have little in common. How can we compare, for instance, small British building societies or local (sometimes “single window”) Italian cooperative banks with a

herland Rabobank, or French Crédit Agricole? Despite their differences, alternative banks share three core characteristics that differ from what is often seen as the typical bank in academic research and policy making debates: the joint-stock, for-

niversal bank. The three core characteristics of alternative banks are:

profit, i.e. they do not aim to maximize shareholder value or returns for owners. This does not mean that alternative banks do not

-profit banks. However, the corporate missions of alternative banks retain a broad range of explicitly stated objectives, to be sustained by returns, such as favoring economic and social development, financing local projects, making credit available to poorer households or small businesses, and providing long term investments in social and cultural capital and public policies.

stakeholder-oriented and centered in the sense that they: (a) are not run for the exclusive benefit of

(b) are controlled by a broader range of stakeholders than for-profit banks eratives), government

representatives (and often clients) in the case of savings banks, and regional or national governments in the case of special purpose or development banks, and; (c) are managed by

closer supervision and control than

: The business models of alternative banks differ from private bank business term oriented strategies to

public policy missions through returns, and; (b) corporate cultures and missions that value the social, cultural and developmental needs of their geographic areas or

pecificities presented by each of these -profit banks.

Table 1. Comparing alternative banks and private banks Private

banks1

Savings banks

Stakehold

er

Shareholders

Local, regional or national governments

Mission Profit Provide savings and banking services to citizens; Safeguard savings; financial education; public and SME finance; social and cultural projec(public housing; regional development; government services).

Local

rooting2

Weak Strong

These three characteristics of alternative banks are mutually reinforcing. The absence

of profit maximization motives weakens potential residual claims of shareholders (when they exist, to use terms dear to property rights theorists). And, viceand board-centered governance help maintain a broad range of corporate goals, often written in bank statutes and mission statements. Both stakeholderon sustainable returns instead of risky operations and profit maximization help lengthen the business horizons of alternative banks. The local, regional or national rooting of alternative banks in social organizations and government instpolitical forces play as stakeholders in alternative bank governance. To explain how these three characteristics of alternative banks provide competitive advantages over private banks, we first turn to the historical development of alternative banking groups, then to banking theory, and finally to heterodox theories of the firm and institutional foundations of competitive advantage.

2) Alternative Banking History

Alternative banks emerged alongside private coEuropean history (Mettenheim and Butzbach, 2014). Savings banks were founded by municipalities and other local entities throughout Europe in the late 18th and early 19century (Mura, 1996). But savings banks remanagement; to the pawn-credit foundations of religious orders in medieval Italy; and to the

1 The key features of for-profit bankthe firm discussed below. Private banks may also have social missions that temper profit maximization for owners or shareholders. However, there is widespread view that most large, commercial have seen their focus gradually shift towards profit maximization in the past thirty years, as a result of the process known as “financialization” (see Berger et al., 2010). The four categories of banks presented in table 1 are ideal-types.2 Understood here as a combination of (i) the importance of local stakeholders in the governance of the bank and (ii) the local focus of the banks’ activities.


8

Table 1. Comparing alternative banks and private banks Savings banks Cooperative

banks

Local, regional or national governments

Members

Provide savings and banking services to citizens; Safeguard savings; financial education; public and SME finance; social and cultural project funding (public housing; regional development; government services).

Pool member resources to secure and improve access to credit and contribute to local community development.

Strong Strong

These three characteristics of alternative banks are mutually reinforcing. The absence of profit maximization motives weakens potential residual claims of shareholders (when they

xist, to use terms dear to property rights theorists). And, vice-versa, stakeholdercentered governance help maintain a broad range of corporate goals, often written

in bank statutes and mission statements. Both stakeholder-oriented governance and a focus on sustainable returns instead of risky operations and profit maximization help lengthen the business horizons of alternative banks. The local, regional or national rooting of alternative banks in social organizations and government institutions strengthens the role that social and political forces play as stakeholders in alternative bank governance. To explain how these three characteristics of alternative banks provide competitive advantages over private banks,

orical development of alternative banking groups, then to banking theory, and finally to heterodox theories of the firm and institutional foundations of

2) Alternative Banking History

Alternative banks emerged alongside private commercial and merchant banking very early in European history (Mettenheim and Butzbach, 2014). Savings banks were founded by municipalities and other local entities throughout Europe in the late 18th and early 19century (Mura, 1996). But savings banks remit further back in history; to early Christian fund

credit foundations of religious orders in medieval Italy; and to the

profit banks summarized here are taken from banking theory and theories of the firm discussed below. Private banks may also have social missions that temper profit maximization for owners or shareholders. However, there is widespread view that most large, commercial have seen their focus gradually shift towards profit maximization in the past thirty years, as a result of the process known as “financialization” (see Berger et al., 2010). The four categories of banks

types. ood here as a combination of (i) the importance of local stakeholders in the governance of the

bank and (ii) the local focus of the banks’ activities.


Special

purpose banks

State agencies

improve access

local community

National or regional development; mobilize private capital for public finance; secure SME access to credit.

Weak

These three characteristics of alternative banks are mutually reinforcing. The absence of profit maximization motives weakens potential residual claims of shareholders (when they

versa, stakeholder-oriented centered governance help maintain a broad range of corporate goals, often written

rnance and a focus on sustainable returns instead of risky operations and profit maximization help lengthen the business horizons of alternative banks. The local, regional or national rooting of alternative

itutions strengthens the role that social and political forces play as stakeholders in alternative bank governance. To explain how these three characteristics of alternative banks provide competitive advantages over private banks,

orical development of alternative banking groups, then to banking theory, and finally to heterodox theories of the firm and institutional foundations of

mmercial and merchant banking very early in European history (Mettenheim and Butzbach, 2014). Savings banks were founded by municipalities and other local entities throughout Europe in the late 18th and early 19th

mit further back in history; to early Christian fund credit foundations of religious orders in medieval Italy; and to the

s summarized here are taken from banking theory and theories of the firm discussed below. Private banks may also have social missions that temper profit maximization for owners or shareholders. However, there is widespread view that most large, commercial banks have seen their focus gradually shift towards profit maximization in the past thirty years, as a result of the process known as “financialization” (see Berger et al., 2010). The four categories of banks

ood here as a combination of (i) the importance of local stakeholders in the governance of the

Monti di pieta savings and pawn banks founded throughout Italy in the 15(Menhegin, 1986). Raiffeisen and SchultzGerman speaking areas after hunger and economic crisis ravaged small farmers and communities in the late 1840s. Development banks were created throughout Europe during the 19th century and developing countries in the 20accelerate industrialization (Aghion, 1999; Zysman, 1983; Diamond, 1957). In Europe, (and European colonies), government postal banks rapidly improved access to payment services and savings accounts after the 1860s. Alternative banks were captured in the 20Prime ministers eager to bypass parliaments tapped postal savings deposits for public finance and war. Fascist and Stalinist governments took over, often by force, cooperative basavings banks. From 1945-80, alternative banks were instrumental for recovery from war and sustaining growth across Europe (Shonfield, 1965); remaining critical institutions for complementary relations (Schmidt and Tyrell, 2001) with public savingsand other core features of Welfare States. The following sections indicate the importance of alternative banking histories and the need for further research.

2.1. Italy

Alternative banks retained substantial market shares during the lareforms in the 1990s transformed most banks into jointTable 2 reports the credit provided by different types of banks in Italy from 1861During this period, private banks decline from just oshare of credit in Italy. While savings banks and Monti di pieta, popular banks and credit cooperatives maintained substantial shares of lending during this period of development and credit market deepening, newlymarket share to over 13 percent by 1910. Table 2) Italian Credit Institution Loans, 1861

Savings Banks &Year Private Monti di pietà1861 38.7 38.71870 47.1 137.41880 213.0 234.01890 362.3 391.91900 331.9 367.41910 1.029.7 857.7

Source: De Bonis et al (2012) “New Time Series on the Activity of Banks and Other Financial Institutions from 1861 to 2011.” The importance of branch office networks for relational banking and other institutional foundations of competitive advantage are discussed below. Tbranch offices held by different types of banks in Italy from 1936bank share of branch office networks declines to below half of the total number. Instead, credit institutes, national-interest banks, pbanks expand their shares of branch offices in the posteconomy.


9

Monti di pieta savings and pawn banks founded throughout Italy in the 15n and Schultz-Delitz credit cooperatives were founded across

German speaking areas after hunger and economic crisis ravaged small farmers and communities in the late 1840s. Development banks were created throughout Europe during

ping countries in the 20th century to finance infrastructure and accelerate industrialization (Aghion, 1999; Zysman, 1983; Diamond, 1957). In Europe, (and European colonies), government postal banks rapidly improved access to payment services

ccounts after the 1860s. Alternative banks were captured in the 20Prime ministers eager to bypass parliaments tapped postal savings deposits for public finance and war. Fascist and Stalinist governments took over, often by force, cooperative ba

80, alternative banks were instrumental for recovery from war and sustaining growth across Europe (Shonfield, 1965); remaining critical institutions for complementary relations (Schmidt and Tyrell, 2001) with public savings, pension programs and other core features of Welfare States. The following sections indicate the importance of alternative banking histories and the need for further research.

Alternative banks retained substantial market shares during the late 19th reforms in the 1990s transformed most banks into joint-stock firms through privatizations. Table 2 reports the credit provided by different types of banks in Italy from 1861During this period, private banks decline from just over half market share to a third of market share of credit in Italy. While savings banks and Monti di pieta, popular banks and credit cooperatives maintained substantial shares of lending during this period of development and credit market deepening, newly founded government special credit institutes increased market share to over 13 percent by 1910.

Table 2) Italian Credit Institution Loans, 1861-1910 (billion euros)

Savings Banks & Popular Banks & Gov. SpecialMonti di pietà Credit Coops Cred. Institutes

38.7 1.5137.4 20.4 23.3234.0 92.7 144.6391.9 209.1 427.0367.4 234.4 349.1857.7 652.1 379.2

al (2012) “New Time Series on the Activity of Banks and Other Financial Institutions from 1861 to 2011.”

The importance of branch office networks for relational banking and other institutional foundations of competitive advantage are discussed below. Table 3 reports the number of branch offices held by different types of banks in Italy from 1936-1966. Again, the private bank share of branch office networks declines to below half of the total number. Instead,

interest banks, popular coops, savings and Monti, and rural savings banks expand their shares of branch offices in the post-war period of growth and social


Monti di pieta savings and pawn banks founded throughout Italy in the 15th century Delitz credit cooperatives were founded across

German speaking areas after hunger and economic crisis ravaged small farmers and communities in the late 1840s. Development banks were created throughout Europe during

century to finance infrastructure and accelerate industrialization (Aghion, 1999; Zysman, 1983; Diamond, 1957). In Europe, (and European colonies), government postal banks rapidly improved access to payment services

ccounts after the 1860s. Alternative banks were captured in the 20th century. Prime ministers eager to bypass parliaments tapped postal savings deposits for public finance and war. Fascist and Stalinist governments took over, often by force, cooperative banks and

80, alternative banks were instrumental for recovery from war and sustaining growth across Europe (Shonfield, 1965); remaining critical institutions for

, pension programs and other core features of Welfare States. The following sections indicate the importance of

century until stock firms through privatizations.

Table 2 reports the credit provided by different types of banks in Italy from 1861-1910. ver half market share to a third of market

share of credit in Italy. While savings banks and Monti di pieta, popular banks and credit cooperatives maintained substantial shares of lending during this period of development and

founded government special credit institutes increased

Total 79.0

228.3 684.2

1.390.3 1.282.8 2.918.7

al (2012) “New Time Series on the Activity of Banks and Other Financial

The importance of branch office networks for relational banking and other institutional able 3 reports the number of

1966. Again, the private bank share of branch office networks declines to below half of the total number. Instead,

opular coops, savings and Monti, and rural savings war period of growth and social

Table 3) Branch Offices of Types of Banks, Italy 1936

Year J-Stock* Credit Co´s* Other*1936 1929 22151940 1502 16961950 1778 19431960 2087 22291966 2334 2459

*=private banks Fonte: Banca d'Italia, (1977). Struttura funzionale e territoriale del sistema bancario italiano 1936-1974, Rome 1977.

In Italy, reforms during the 1990s and 2000s privdirected government credit channels in favour of private banking. However, instead of wholesale privatization, shares were allocated to savings banks foundations designed to continue the social and cultural missions of savibank change across Europe. 2.2. Germany Alternative banking in Germany emerged during the 19shares since. Indeed, studies of banking in Germany use the concept of three pillars describe the largely equal market shares, since the 19(pillar one), cooperative banks (pillar two) and local and regional government savings banks (pillar three) (Schmidt et al, 2014). Table 4) German Sparkasse Sav

Year Banks Offices Accounts1839 85 1845 157 1850 234 2781471855 323 4235421865 517 9195131875 1005 22091011885 1318 1485 42094531895 1493 2448 68766641900 1490 2828 86707091910 1711 4619 129003041913 1765 5268 14417642

Balance = Millon marks, Avg and per cap Balance = marksSource: Büschegen, H. E. (1983: 399).

Sparkasse savings banks, the third pillar, grew from 85 institutions in 1839 to 1765 mostly municipal government banks by 1920savings accounts, number of accounts per 100 residents and balance per capita population suggest that past debates about public savings banks in Germany remain relevant for


10

Table 3) Branch Offices of Types of Banks, Italy 1936-1966

Credit National Popular Savings &

Other* Institutes Banks Coops Monti192 935 607 1161 1536136 996 577 946 1664109 1183 661 1142 2131114 1371 737 1476 2632

96 1501 791 1695 2940

Struttura funzionale e territoriale del sistema , Rome 1977.

In Italy, reforms during the 1990s and 2000s privatized savings banks and reduced directed government credit channels in favour of private banking. However, instead of wholesale privatization, shares were allocated to savings banks foundations designed to continue the social and cultural missions of savings banks. This is just one permutation of

Alternative banking in Germany emerged during the 19th century to retain large market shares since. Indeed, studies of banking in Germany use the concept of three pillars describe the largely equal market shares, since the 19th century, retained by private banks (pillar one), cooperative banks (pillar two) and local and regional government savings banks (pillar three) (Schmidt et al, 2014).

Table 4) German Sparkasse Savings Banks, 1839-1913

AccountsAccts per 100 pop. Balance

Avg. Balance

1838

278147 54 195.4 423542 97 228.7 919513 268 291.3

2209101 8.6 1112 503.4 4209453 14.8 2261 537.1 6876664 21.5 4345 631.9 8670709 25.1 5746 662.6

12900304 32.1 11107 860.1 17642 34.2 13111 909.4

Balance = Millon marks, Avg and per cap Balance = marks Büschegen, H. E. (1983: 399).

Sparkasse savings banks, the third pillar, grew from 85 institutions in 1839 to 1765 mostly municipal government banks by 1920. Historical data on the average balance of savings accounts, number of accounts per 100 residents and balance per capita population suggest that past debates about public savings banks in Germany remain relevant for


Savings & RuralMonti Savings Total1536 1202 76561664 987 68662131 691 77512632 758 92032940 813 10199

Struttura funzionale e territoriale del sistema

atized savings banks and reduced directed government credit channels in favour of private banking. However, instead of wholesale privatization, shares were allocated to savings banks foundations designed to

ngs banks. This is just one permutation of

century to retain large market shares since. Indeed, studies of banking in Germany use the concept of three pillars to

century, retained by private banks (pillar one), cooperative banks (pillar two) and local and regional government savings banks

Balance per-cap. pop.

1.242.373.29

5.613.843.279.5

136.3166.4276.2311.4

Sparkasse savings banks, the third pillar, grew from 85 institutions in 1839 to 1765 . Historical data on the average balance of

savings accounts, number of accounts per 100 residents and balance per capita population suggest that past debates about public savings banks in Germany remain relevant for

discussions of financial inclusion and of the 20th century, the “Sparkasse question” turned on whether increasing values of savings deposits at savings banks indicated drift from social missions that increased risk (because of more volatile middle class and business depositors), or whether traditional clients had instead simply accumulated savings over time. The latter position prevailed, while further debates ensued about the role of small savings of the poor in savings banks helped amelor exacerbate, the business cycle (Seidel, 1909).

A core competitive advantageindependent local banks and a shared wholesale finance group (the Finanzgruppe Deutscher Sparkassen- und Giroverband, FDSG) that offers banking, finance and insurance services through the retail branch offices and outlets of independent local and regional savings banks. The wholesale operations of German savings banks emerged in the late 19led in the development of many capital market products and financial services innovations throughout the 20th and into the 21German savings banks (reported together as the Sparkasse Finance Group) remained ovtrillion euros, far greater than the assets held by any of the largest private banks in the world. The German savings bank finance group includes 6,201 banks and firms holding 21,700 branch offices and 366,500 employees (See Table 5). In sum, since and transition to European Community regulations, German savings banks have retained and increased market shares and retain their traditional predominance in retail banking, savings, insurance, local and regional public finance anservices. Table 5) The German Sparkasse Finance Group, 2009

Sparkasse Finance Group Sparkasse Savings Banks Landesbank Groups DekaBank giro center bank Sparkasse Insurance Group Regional mortgage savings banksLeasing Groups Capital Market Groups Factoring Groups Finance IT Division LBS Real Estate Commune Management Firms

Source: Finanzgruppe Deutscher Sparkassen

The second pillar of alternative banking in Germany is composed of cooperative banking groups that remit to Raiffeissen and Schultz1840s. The number of credit cooperatives in Germany also increased geometrically, from 133 to 1245 banks 1860-1920, reaching over 746 thousand members in 1920. And like the trajectory of savings banks, the growth of German cooperative banks reflect a traditional business model of deposit-taking and loan making, with conservative levels of capital reserves and members balances. Table 6 reports the accumulation of savings, assemembers and reserves by credit cooperatives in Germany from 1860


11

discussions of financial inclusion and social banking today (Schmidt, 2009). In the first decade century, the “Sparkasse question” turned on whether increasing values of savings

deposits at savings banks indicated drift from social missions that increased risk (because of ile middle class and business depositors), or whether traditional clients had

instead simply accumulated savings over time. The latter position prevailed, while further debates ensued about the role of small savings of the poor in savings banks helped amelor exacerbate, the business cycle (Seidel, 1909).

A core competitive advantage of savings banks is their two tier structure composed of independent local banks and a shared wholesale finance group (the Finanzgruppe Deutscher

rband, FDSG) that offers banking, finance and insurance services through the retail branch offices and outlets of independent local and regional savings banks. The wholesale operations of German savings banks emerged in the late 19

n the development of many capital market products and financial services innovations and into the 21st century. In 2010, the combined balance sheets of

German savings banks (reported together as the Sparkasse Finance Group) remained ovtrillion euros, far greater than the assets held by any of the largest private banks in the world. The German savings bank finance group includes 6,201 banks and firms holding 21,700 branch offices and 366,500 employees (See Table 5). In sum, since liberalization of banking and transition to European Community regulations, German savings banks have retained and increased market shares and retain their traditional predominance in retail banking, savings, insurance, local and regional public finance and a variety of niches in banking and financial

Table 5) The German Sparkasse Finance Group, 2009 Branch Balance

Firms Offices Staff Sheet*6201 21,700 366,500 3,410

631 15,685 258,737 1,0737 50,476 1,6891 3,667 1331 30,000 17

Regional mortgage savings banks 10 8,896 525 10,595 73

85 1,447 506 23 213 12

5,375 10 455 4

8 Source: Finanzgruppe Deutscher Sparkassen- und Giroverband. 2010. p. 2

The second pillar of alternative banking in Germany is composed of cooperative ps that remit to Raiffeissen and Schultz-Delitz credit cooperatives founded in the

1840s. The number of credit cooperatives in Germany also increased geometrically, from 133 1920, reaching over 746 thousand members in 1920. And like the

trajectory of savings banks, the growth of German cooperative banks reflect a traditional taking and loan making, with conservative levels of capital reserves

and members balances. Table 6 reports the accumulation of savings, assets, and balances for members and reserves by credit cooperatives in Germany from 1860-1920.


social banking today (Schmidt, 2009). In the first decade century, the “Sparkasse question” turned on whether increasing values of savings

deposits at savings banks indicated drift from social missions that increased risk (because of ile middle class and business depositors), or whether traditional clients had

instead simply accumulated savings over time. The latter position prevailed, while further debates ensued about the role of small savings of the poor in savings banks helped ameliorate,

of savings banks is their two tier structure composed of independent local banks and a shared wholesale finance group (the Finanzgruppe Deutscher

rband, FDSG) that offers banking, finance and insurance services through the retail branch offices and outlets of independent local and regional savings banks. The wholesale operations of German savings banks emerged in the late 19th century and have

n the development of many capital market products and financial services innovations century. In 2010, the combined balance sheets of

German savings banks (reported together as the Sparkasse Finance Group) remained over 3.4 trillion euros, far greater than the assets held by any of the largest private banks in the world. The German savings bank finance group includes 6,201 banks and firms holding 21,700

liberalization of banking and transition to European Community regulations, German savings banks have retained and increased market shares and retain their traditional predominance in retail banking, savings,

anking and financial

Balance Sheet*

3,410 73

1,689 133

17 52 73

2 12

4

und Giroverband. 2010. p. 2

The second pillar of alternative banking in Germany is composed of cooperative Delitz credit cooperatives founded in the

1840s. The number of credit cooperatives in Germany also increased geometrically, from 133 1920, reaching over 746 thousand members in 1920. And like the

trajectory of savings banks, the growth of German cooperative banks reflect a traditional taking and loan making, with conservative levels of capital reserves

ts, and balances for 1920.

Table 6) German Credit Cooperatives, 1860

Year Coops Members Assets Credit1860 133 316031870 740 314656 1871880 905 460656 4931890 1072 518003 6201900 870 511061 8061910 939 600387 14771920 1245 746058 7158

Source: Deutsche Bundesbank. (Frankfurt: Deutsche Bundesbank, 1976), pp. 344

The “three pillars” expression actually underestimates the importance of alternative banking in Germany because it omits federal and provincial government special purposbanks. German special purpose banks retain an additional 10 percent market share of banking in the country, depending on the sector, product and service (Schmidt et al, 2014; Krahnen and Schmidt, 2005; Deeg, 1999). Table 7 reports the balance sheet, numbownership of the twenty special purpose banks in Germany in 2010. These institutions held 834.4 billion euros on balance sheets with 12,730 employees, serving provincial Lande and federal governments by leading bank consortia and tapping capublic sector and home finance, and construction of public buildings, infrastructure modernization, environmental investments and the greening of industry, and health and other social service provision. Table 7) German Special Purpose Banks, 2010

Federal Government Special Purpose BanksKfW Bank Group Landwirtschaftliche Rentenbank State Government Special Purpose Ban

Investitionsbank Schleswig-Holstein Bremer Aufbau-Bank Hamburgische WohnungsbaukreditanstaltNBank Invest. und Förderbank NiedersachsenNRW Bank (Nordrhein Westfalen Bank)Investitions- und Strukturbank RheinlandLTH, Landestreuhandbank RheinlandSIKB Saarländische InvestitionskreditbankL-Bank, Landeskreditbank Baden-WürttembergLfA Förderbank Bayern Bayerische LandesbodenkreditanstaltLandesförderinstitut Mecklenburg-VorpommernInvestitionsbank Berlin Investitions Bank des Landes BrandenburgInvestionsbank Sachsen-Anhalt Thüringer Aufbaubank Sächsische Aufbaubank Förderbank Wirtschafts- und Infrastrukturbank Total 12,730 834.4Source: Association of German Public * billion euros **100% where % not reported


12

) German Credit Cooperatives, 1860-1920 Savings Member

Credit Deposits Balance Reserves 7 1 0

166 131 40 4438 353 102 16538 438 117 28672 586 133 45

1202 1084 216 944026 6480 391 164

Source: Deutsche Bundesbank. Deutsches Geld- und Bankwesen in Zahlen 1876(Frankfurt: Deutsche Bundesbank, 1976), pp. 344-5

The “three pillars” expression actually underestimates the importance of alternative banking in Germany because it omits federal and provincial government special purposbanks. German special purpose banks retain an additional 10 percent market share of banking in the country, depending on the sector, product and service (Schmidt et al, 2014; Krahnen and Schmidt, 2005; Deeg, 1999). Table 7 reports the balance sheet, number of staff and ownership of the twenty special purpose banks in Germany in 2010. These institutions held 834.4 billion euros on balance sheets with 12,730 employees, serving provincial Lande and federal governments by leading bank consortia and tapping capital markets, especially in public sector and home finance, and construction of public buildings, infrastructure modernization, environmental investments and the greening of industry, and health and other

l Purpose Banks, 2010 Balance

Federal Government Special Purpose Banks Staff Sheet* Majority Ownership**4600 400.1 80% Fed. 20% State Govts.

218 75.8 Fed. Govt.State Government Special Purpose Banks

460 16.7 Schleswig55 1.3 Bremen Holding

Hamburgische Wohnungsbaukreditanstalt 185 5.1 Hamburg NBank Invest. und Förderbank Niedersachsen 426 5.7 Niedersachsen

Nordrhein Westfalen Bank) 1224 161 98.6% Nordrheinund Strukturbank Rheinland-Pfalz 186 8.5 Rhein-Pfalz

LTH, Landestreuhandbank Rheinland-Pfalz 98 1.9 Rhein-PfalzSIKB Saarländische Investitionskreditbank 66 1.2 51% Saar

Württemberg 1230 59.7 Baden-Württemberg344 19.4 Freistaat Bayern

Bayerische Landesbodenkreditanstalt 227 21.2 Bayrischen esbankVorpommern 246 2.5 NORD LB

673 20.4 Berlin Investitions Bank des Landes Brandenburg 505 11.8 50% Brandenburg, 50% NRW Bank

349 1.3 NORD/LB336 2.5 Freistaat Thüringen

905 8.7 Freistaat Sachsen 397 9.6 Landesbank Hessen

Total 12,730 834.4 Source: Association of German Public Sector Banks (Bundesverband Öffentlicher Banken Deutschlands, VÖB)

not reported


und Bankwesen in Zahlen 1876-1975.

The “three pillars” expression actually underestimates the importance of alternative banking in Germany because it omits federal and provincial government special purpose banks. German special purpose banks retain an additional 10 percent market share of banking in the country, depending on the sector, product and service (Schmidt et al, 2014; Krahnen

er of staff and ownership of the twenty special purpose banks in Germany in 2010. These institutions held 834.4 billion euros on balance sheets with 12,730 employees, serving provincial Lande and

pital markets, especially in public sector and home finance, and construction of public buildings, infrastructure modernization, environmental investments and the greening of industry, and health and other

Majority Ownership** 80% Fed. 20% State Govts. Fed. Govt.

Schleswig-Holstein Bremen Holding Hamburg Niedersachsen 98.6% Nordrhein-Westfalen

Pfalz Pfalz

51% Saar Württemberg

Freistaat Bayern Bayrischen esbank NORD LB

50% Brandenburg, 50% NRW Bank NORD/LB Freistaat Thüringen Freistaat Sachsen Landesbank Hessen-Thüringen

Sector Banks (Bundesverband Öffentlicher Banken Deutschlands, VÖB)

Further research will be required to understand why some regional Landesbanks were caught in crisis and have been charged with corruptiohave called for fundamentally changing special purpose banks and their links to savings banks (Hilgerth et al, 2011). However, not all German special purpose banks incurred losses and, as a whole, appear to have been crcrisis in 2007-8. Table 8 reports the lending of German special purpose banks from 2008by sector and as a whole. Total investments from German special purpose banks increased from 6.78-9.09 billion 2008-9 just as private banks incurred major losses from exposures in capital markets (Hardie and Howith, 2013a) (See Table 8). Table 8) German Special Purpose Bank Finance and Credit, 2008Sector Commercial Local Government Home & Public Construction Agriculture and Agroindustry Other Total

Source: Bundesverband Öffentlicher Banken Deutschlands. (2013). p. 2 Several comparative advantages of German alternative banks appear in data on bank performance reported by the German Bundebanks over private banks is marked; the cost of administrative expenses. Given the small central offices of government special purpose banks, and the sharing of wholesale operations by “national” cooperative banks, these institutions reduced administrative costs in proportion to income from 0.66 to 0.38 and 0.25 to 0.17 from 1970Meanwhile, private banks have reduced the costs of administration (2.9big banks and regional banks). In comparison, savings banks and regional cooperative banks that retain large retail networks of branch offices reduced administrative costs to remain just above levels reported by regional private banks. Table 9) Administrative Expenses by Type of German Bank, 1970

Private

Year Big Regional Savings

1970 2.90 1.91 1980 2.40 1.65 1990 2.25 1.80 2000 1.51 2.08 2010 1.20 1.67

Source: Deutsche Bundesbank (2012). Available on www.bundesbank.de

3 Further data comparing the performance of German private banks, savings banks, cooperative banks and special purpose banks are presented in Tables 1


13

Further research will be required to understand why some regional Landesbanks were caught in crisis and have been charged with corruption and crony finance and credit. Some have called for fundamentally changing special purpose banks and their links to savings banks (Hilgerth et al, 2011). However, not all German special purpose banks incurred losses and, as a whole, appear to have been critical for provision of counter cyclical finance and credit since

8. Table 8 reports the lending of German special purpose banks from 2008by sector and as a whole. Total investments from German special purpose banks increased

9 just as private banks incurred major losses from exposures in capital markets (Hardie and Howith, 2013a) (See Table 8).

Table 8) German Special Purpose Bank Finance and Credit, 2008-12, million euros 2008 2009 2010 2011 2012

3,851.2 4,611.4 3,913.6 3,581.0 3,430.41,030.2 1,826.5 1,249.8 1,247.4 823.7

835.3 1,173.8 983.9 1,020.9 785.791.3 386.7 386.2 379.4 387.1

976.8 109.4 1,141.9 1,003.5 944.16,784.7 9,092.9 7,675.4 7,232.2 6,371.0

Source: Bundesverband Öffentlicher Banken Deutschlands. (2013). p. 2

Several comparative advantages of German alternative banks appear in data on bank performance reported by the German Bundesbank. One competitive advantage of alternative banks over private banks is marked; the cost of administrative expenses. Given the small central offices of government special purpose banks, and the sharing of wholesale operations

banks, these institutions reduced administrative costs in proportion to income from 0.66 to 0.38 and 0.25 to 0.17 from 1970-2010 respectively (See Table 9). Meanwhile, private banks have reduced the costs of administration (2.9-1.2 and 1.91

nks and regional banks). In comparison, savings banks and regional cooperative banks that retain large retail networks of branch offices reduced administrative costs to remain just above levels reported by regional private banks.3

Expenses by Type of German Bank, 1970-2010

Coops Government

Savings National Regional Sp. Purpose

2.16 0.66 2.72 0.25 2.23 0.67 2.66 0.23 2.11 0.66 2.63 0.24 1.99 0.56 2.39 0.15 1.74 0.38 1.88 0.17

Source: Deutsche Bundesbank (2012). Available on www.bundesbank.de

Further data comparing the performance of German private banks, savings banks, cooperative banks ecial purpose banks are presented in Tables 1-5 and Figure 1 in the Appendix.


Further research will be required to understand why some regional Landesbanks were n and crony finance and credit. Some

have called for fundamentally changing special purpose banks and their links to savings banks (Hilgerth et al, 2011). However, not all German special purpose banks incurred losses and, as

itical for provision of counter cyclical finance and credit since 8. Table 8 reports the lending of German special purpose banks from 2008-12,

by sector and as a whole. Total investments from German special purpose banks increased 9 just as private banks incurred major losses from exposures in

12, million euros 2012

3,430.4 823.7 785.7 387.1 944.1

6,371.0

Several comparative advantages of German alternative banks appear in data on bank sbank. One competitive advantage of alternative

banks over private banks is marked; the cost of administrative expenses. Given the small central offices of government special purpose banks, and the sharing of wholesale operations

banks, these institutions reduced administrative costs in proportion 2010 respectively (See Table 9).

1.2 and 1.91-1.67 for nks and regional banks). In comparison, savings banks and regional cooperative banks

that retain large retail networks of branch offices reduced administrative costs to remain just

Landes

0.56 0.51 0.47 0.43 0.44

Further data comparing the performance of German private banks, savings banks, cooperative banks 5 and Figure 1 in the Appendix.

In sum, local government savings banks, community banks and special purpose banks emerged during the 19th century. They were soon challenged by official government postal savings banks.

2.3 Postal Savings Banks

Beginning in the UK in 1862, European governments began to offer savings accounts and other banking services through postal savings bankbranch office networks. Postal savings banks rapidly acquired large numbers of depositors and mobilized large quantities of savings deposits. From 1862bank increased the number of branch ofdepositors increased from 178,495 to over 11 million (more than 25 percent of the population), and the value of deposits from 8.2 savings banks experienced similacolonial holdings before World War I (National Monetary Commission, 1909). Table 10) Postal Savings Banks, UK, France and Italy, 1862UK Postal Savings Banks, 1862-

Year Offices Depositors 1862 2,535 178,495 1870 4,082 1,183,153 1880 6,233 2,184,972 1890 9,681 4,827,314 1900 13,341 8,439,983 1908 15,239 11,018,251

France Postal Savings Bank 1882Year Offices Depositors 1882 6,024 211,580 1890 6,817 1,475,820 1900 7,697 3,565,941 1908 5,291,673 Italy Postal Savings Bank, 1876Year Offices Depositors 1876 1,989 57,354 1880 3,313 339,845 1890 4,479 2,126,289 1900 5,143 3,990,983 1908 8,735 4,981,920

Source: National Monetary Commission, 1909, pp. 34

Postal savings banks also became central to coloinstitutions from colonial rule, were retained by new independent governments in developing countries for their branch office networks and ability to mobilize savings and provide payment services. The creation of the China branch offices suggests both the continuing importance of this type of alternative bank and the need for further research on these institutions.


14

In sum, local government savings banks, community banks and special purpose banks century. They were soon challenged by official government postal

Beginning in the UK in 1862, European governments began to offer savings accounts and other banking services through postal savings banks designed to use vast postal service branch office networks. Postal savings banks rapidly acquired large numbers of depositors and mobilized large quantities of savings deposits. From 1862-1908, the UK Postal Savings bank increased the number of branch offices from 2,535 to 15,239; while the number of depositors increased from 178,495 to over 11 million (more than 25 percent of the population), and the value of deposits from 8.2 – 781.8 billion US dollars (Table 10). Postal savings banks experienced similar geometric growth trajectories throughout Europe and colonial holdings before World War I (National Monetary Commission, 1909).

Table 10) Postal Savings Banks, UK, France and Italy, 1862-1908 -1908

Deposits (US$)

8,264,392 73,479,789

164,218,275 329,145,788 659,652,347 781,794,533

France Postal Savings Bank 1882-1908 Deposits (US$)

9,187,116 79,793,736

194,980,796 296,964,867

Italy Postal Savings Bank, 1876-1908 Deposits (US$)

471,577 8,926,802

59,923,342 131,652,255 290,808,886

Source: National Monetary Commission, 1909, pp. 34-44

Postal savings banks also became central to colonial government and, unlike most institutions from colonial rule, were retained by new independent governments in developing countries for their branch office networks and ability to mobilize savings and provide payment services. The creation of the China Postal Savings Bank in 2007 with over 40,000 branch offices suggests both the continuing importance of this type of alternative bank and the need for further research on these institutions.


In sum, local government savings banks, community banks and special purpose banks century. They were soon challenged by official government postal

Beginning in the UK in 1862, European governments began to offer savings accounts and s designed to use vast postal service

branch office networks. Postal savings banks rapidly acquired large numbers of depositors 1908, the UK Postal Savings

; while the number of depositors increased from 178,495 to over 11 million (more than 25 percent of the

billion US dollars (Table 10). Postal r geometric growth trajectories throughout Europe and

colonial holdings before World War I (National Monetary Commission, 1909).

nial government and, unlike most institutions from colonial rule, were retained by new independent governments in developing countries for their branch office networks and ability to mobilize savings and provide

Postal Savings Bank in 2007 with over 40,000 branch offices suggests both the continuing importance of this type of alternative bank and

Alternative banks have played important roles in a variety of bansystems for centuries, especially in terms of mobilizing savings deposits and public finance. Given the long history and wide variety of alternative banks, it is difficult to measure the overall importance of these institutions. IndustryBanks Institute and the European Cooperative Banks Association provide information about their member banks, but no independent aggregate data exists for public development banks, despite their importance in many advimportance of alternative banks varies widely across sectors, countries and regions, these institutions may not appear in standard measures of banking activity. Fto market shares of UK bank deposits, building societies (mutual banks specialized in mortgage lending) appear marginal in the 1990s while, in fact, they remained dominant players in mortgage lending. Local and regional savings banks and cooperative banks appear most prevalent in Continental Europe (Groenewald, 2014; Schmidt centralized government development banks and savings banks or institutes remain at the center of large emerging economies such as Brazil, India and China (Mettenheim, 2014).

In sum, it is fair to say that given the importance of alternative banks in of banking and many financial systems, these institutions have indeed been historically significant and deserve more attention in banking studies.

3 Alternative banks after liberalization, deregulation, privatizations and IT revolution

Even where alternative banks traditionally retained large market shares and critical roles in banking and finance, fundamental changes since 1980 in the legal, regulatory and managerial/business environment of banking have threatened their survival. Reforms in many countries radically altered banking through: (a) destrict separation between segments of banking markets such as shortand long-term lending; household and corporate lending; and retail and wholesale banking (a typical example is the 1999 Grammcore provisions of the already weakened Glassbanks and securities firms); (b) financial market liberalization that reduced legal and regulatory barriers to entry; (c) price liberalization to reduce or end administered credit in state-dominated financial systems such as France or Italy interest rate controls in countries such as the United Kingdom); (d) statutory normalization designed to end special any legal or regulatory status for alternative banks (usually paving the way for aggregation with joint-allowed British building societies to demutualize; or the 1990 Amatotransformed savings banks and other public banks into joint(e) large scale privatizations of stateenterprises such as France and Italy in Europe as well as many developing, emerging and transition countries.

Since 1980, liberalization, deregulation and privatizations drbanking through waves of mergers and acquisitions. Banks and (such as insurance companies or investment funds) also shifted business strategies away from traditional deposit-taking and loanand services traded directly on capital markets.communication revolutionized banking with new products, services and electronic channels such as ATMs, online banking and mobile banking via cellular phones that bypassed traditional branch offices, personal, face to face provision of services and relational banking.


15

Alternative banks have played important roles in a variety of banking and financial systems for centuries, especially in terms of mobilizing savings deposits and public finance. Given the long history and wide variety of alternative banks, it is difficult to measure the overall importance of these institutions. Industry associations such as the World Savings Banks Institute and the European Cooperative Banks Association provide information about their member banks, but no independent aggregate data exists for public development banks, despite their importance in many advanced and developing countries. Moreover, because the importance of alternative banks varies widely across sectors, countries and regions, these institutions may not appear in standard measures of banking activity. For example, according

f UK bank deposits, building societies (mutual banks specialized in mortgage lending) appear marginal in the 1990s while, in fact, they remained dominant

Local and regional savings banks and cooperative banks appear lent in Continental Europe (Groenewald, 2014; Schmidt et al, 2014); while

centralized government development banks and savings banks or institutes remain at the center of large emerging economies such as Brazil, India and China (Mettenheim, 2014).

it is fair to say that given the importance of alternative banks in financial systems, these institutions have indeed been historically

significant and deserve more attention in banking studies.

liberalization, deregulation, privatizations and IT revolution

Even where alternative banks traditionally retained large market shares and critical roles in banking and finance, fundamental changes since 1980 in the legal, regulatory and

ess environment of banking have threatened their survival. Reforms in many countries radically altered banking through: (a) de-segmentation, in the sense of ending strict separation between segments of banking markets such as short-term money markets

term lending; household and corporate lending; and retail and wholesale banking (a typical example is the 1999 Gramm-Leach-Bliley Act in the United States, which repealed two core provisions of the already weakened Glass-Steagall Act restricting affilibanks and securities firms); (b) financial market liberalization that reduced legal and regulatory barriers to entry; (c) price liberalization to reduce or end administered credit in

dominated financial systems such as France or Italy (or abandon informal systems of interest rate controls in countries such as the United Kingdom); (d) statutory normalization designed to end special any legal or regulatory status for alternative banks (usually paving the

stock banks; for example, the Building Societies Act of 1986 allowed British building societies to demutualize; or the 1990 Amato-Carli law in Italy that transformed savings banks and other public banks into joint-stock companies), and, finally;

le privatizations of state-owned banks in countries with traditions of state owned enterprises such as France and Italy in Europe as well as many developing, emerging and

Since 1980, liberalization, deregulation and privatizations dramatically restructured banking through waves of mergers and acquisitions. Banks and other financial intermediaries (such as insurance companies or investment funds) also shifted business strategies away from

taking and loan-making toward the provision of a wide variety of products and services traded directly on capital markets. Finally, new technologies of information and communication revolutionized banking with new products, services and electronic channels

ing and mobile banking via cellular phones that bypassed traditional branch offices, personal, face to face provision of services and relational banking.


king and financial systems for centuries, especially in terms of mobilizing savings deposits and public finance. Given the long history and wide variety of alternative banks, it is difficult to measure the

associations such as the World Savings Banks Institute and the European Cooperative Banks Association provide information about their member banks, but no independent aggregate data exists for public development banks,

anced and developing countries. Moreover, because the importance of alternative banks varies widely across sectors, countries and regions, these

or example, according f UK bank deposits, building societies (mutual banks specialized in

mortgage lending) appear marginal in the 1990s while, in fact, they remained dominant Local and regional savings banks and cooperative banks appear

, 2014); while centralized government development banks and savings banks or institutes remain at the center of large emerging economies such as Brazil, India and China (Mettenheim, 2014).

it is fair to say that given the importance of alternative banks in some segments financial systems, these institutions have indeed been historically

liberalization, deregulation, privatizations and IT revolution

Even where alternative banks traditionally retained large market shares and critical roles in banking and finance, fundamental changes since 1980 in the legal, regulatory and

ess environment of banking have threatened their survival. Reforms in segmentation, in the sense of ending

term money markets term lending; household and corporate lending; and retail and wholesale banking (a

Bliley Act in the United States, which repealed two Steagall Act restricting affiliations between

banks and securities firms); (b) financial market liberalization that reduced legal and regulatory barriers to entry; (c) price liberalization to reduce or end administered credit in

(or abandon informal systems of interest rate controls in countries such as the United Kingdom); (d) statutory normalization designed to end special any legal or regulatory status for alternative banks (usually paving the

ck banks; for example, the Building Societies Act of 1986 Carli law in Italy that

stock companies), and, finally; owned banks in countries with traditions of state owned

enterprises such as France and Italy in Europe as well as many developing, emerging and

amatically restructured other financial intermediaries

(such as insurance companies or investment funds) also shifted business strategies away from rd the provision of a wide variety of products

Finally, new technologies of information and communication revolutionized banking with new products, services and electronic channels

ing and mobile banking via cellular phones that bypassed traditional branch offices, personal, face to face provision of services and relational banking.

These four interrelated phenomena challenged alternative banks. First, changes in legal status (often into joint stock corporations) and privatizations often abruptly ended the traditional governance structures of alternative banks. Second, the liberalization of markets, and consolidation through mergers and acquisitions pressured localcooperative banks and savings banks to merge with or be acquired by larger forThis process was most marked in the UK and Italy.industries to foreign competition, together with financial maencouraged alternative banks to diversify away their traditional business lines and pay more attention to profitability targets. Although further research will be required, the impact of new technologies on alternative banks appecapable of tapping their competitive advantages.

3.1 Back to the future of alternative banking

In this context, it is surprising to find that many alternative banks survived and continued to perform quite well. The resilience of alternative banks has varied. In countries such as the US and UK, traditional savings banks were marginalized, sector (the US Savings and Loan crisis in the late 1980s) by regulatory reforms (UK building societies lost 4/5 of assets during the 1990s after the largest societies demutualized in accord with the 1986 Building Society Act). However, alternative banks retain large market shares in other countries, both ifunding markets. In France and Germany, cooperative banks and savings banks retain dominant positions in credit and savings markets. After declining during the 1990s, the Rabobank cooperative bank recovered during the 2000s to remain tthe Netherlands. Although China has not opened its banking industry, in other emerging countries such as Brazil and India, state owned banks remain the largest and fastest growing banks long after liberalization and privatizations

Descriptive statistics on market shares are telling, but cannot reveal the competitive advantages of alternative banks. However, recent empirical studies reinforce the view that, even after liberalization, deregulation and adoption of can compete with and indeed outperform private banks. Table 5 in the appendix summarizes recent studies that find cooperative or savings banks to be at least as commercial competitors. Ayadi et acost-efficient as commercial banks (2009). Although German cooperative banks appear slightly less cost efficient, cooperative banks in France, Italy and Spain are largely more cost efficient than their commercial peers (Ayadi et al., 2010). This confirms findings from (Iannotta et al., 2007) that governmentin 15 European countries (in a sample of 181 large banks). slightly higher cost efficiencies with savings and cooperative banks in in 15 European countries and the US 1990to be more cost efficient than private banks in all but three countries. Altunbas et al. (2001) on Germany, Giordano and Lopes (2008) on the Italian cooperative sector, or Ceneboyan (1993) on the US savings and loans sector find similar results. An

4 In the UK, most large building societis choose to decommercial banks in the 1990s; in Italy, most large savings banks, once gramerged with former public banks to form the backbone of the country’s largest jointgroups, Intesa SanPaolo and Unicredit.


16

These four interrelated phenomena challenged alternative banks. First, changes in legal status into joint stock corporations) and privatizations often abruptly ended the traditional

governance structures of alternative banks. Second, the liberalization of banking and credit markets, and consolidation through mergers and acquisitions pressured localcooperative banks and savings banks to merge with or be acquired by larger forThis process was most marked in the UK and Italy.4 Finally, opening national banking industries to foreign competition, together with financial market liberalization, often encouraged alternative banks to diversify away their traditional business lines and pay more attention to profitability targets. Although further research will be required, the impact of new technologies on alternative banks appears to depend on modernization strategies capable of tapping their competitive advantages.

3.1 Back to the future of alternative banking

In this context, it is surprising to find that many alternative banks survived and continued to The resilience of alternative banks has varied. In countries such as the US

and UK, traditional savings banks were marginalized, either through systemic collapse of the sector (the US Savings and Loan crisis in the late 1980s) or through demutualization iby regulatory reforms (UK building societies lost 4/5 of assets during the 1990s after the largest societies demutualized in accord with the 1986 Building Society Act). However, alternative banks retain large market shares in other countries, both in lending and retail funding markets. In France and Germany, cooperative banks and savings banks retain dominant positions in credit and savings markets. After declining during the 1990s, the Rabobank cooperative bank recovered during the 2000s to remain the second largest bank in the Netherlands. Although China has not opened its banking industry, in other emerging countries such as Brazil and India, state owned banks remain the largest and fastest growing banks long after liberalization and privatizations (Mettenheim, 2014).

Descriptive statistics on market shares are telling, but cannot reveal the competitive advantages of alternative banks. However, recent empirical studies reinforce the view that, even after liberalization, deregulation and adoption of new technologies, alternative banks can compete with and indeed outperform private banks. Table 5 in the appendix summarizes recent studies that find cooperative or savings banks to be at least as costcommercial competitors. Ayadi et al. provide evidence that European savings banks are as

efficient as commercial banks (2009). Although German cooperative banks appear slightly less cost efficient, cooperative banks in France, Italy and Spain are largely more cost

r commercial peers (Ayadi et al., 2010). This confirms findings from (Iannotta et al., 2007) that government-owned and cooperative banks are more costin 15 European countries (in a sample of 181 large banks). Altunbaş et al. (2003) also find

ightly higher cost efficiencies with savings and cooperative banks in a sample study of banks in 15 European countries and the US 1990- 2000. Savings and cooperative banks were found to be more cost efficient than private banks in all but three countries. Country studies, such as Altunbas et al. (2001) on Germany, Giordano and Lopes (2008) on the Italian cooperative sector, or Ceneboyan (1993) on the US savings and loans sector find similar results. An

In the UK, most large building societis choose to de-mutualize and then merge with large jointcommercial banks in the 1990s; in Italy, most large savings banks, once granted a jointmerged with former public banks to form the backbone of the country’s largest jointgroups, Intesa SanPaolo and Unicredit.


These four interrelated phenomena challenged alternative banks. First, changes in legal status into joint stock corporations) and privatizations often abruptly ended the traditional

banking and credit markets, and consolidation through mergers and acquisitions pressured local, not-for-profit cooperative banks and savings banks to merge with or be acquired by larger for-profit banks.

Finally, opening national banking rket liberalization, often

encouraged alternative banks to diversify away their traditional business lines and pay more attention to profitability targets. Although further research will be required, the impact of

ars to depend on modernization strategies

In this context, it is surprising to find that many alternative banks survived and continued to The resilience of alternative banks has varied. In countries such as the US

either through systemic collapse of the or through demutualization induced

by regulatory reforms (UK building societies lost 4/5 of assets during the 1990s after the largest societies demutualized in accord with the 1986 Building Society Act). However,

n lending and retail funding markets. In France and Germany, cooperative banks and savings banks retain dominant positions in credit and savings markets. After declining during the 1990s, the

he second largest bank in the Netherlands. Although China has not opened its banking industry, in other emerging countries such as Brazil and India, state owned banks remain the largest and fastest growing

Descriptive statistics on market shares are telling, but cannot reveal the competitive advantages of alternative banks. However, recent empirical studies reinforce the view that,

new technologies, alternative banks can compete with and indeed outperform private banks. Table 5 in the appendix summarizes

cost-efficient as their l. provide evidence that European savings banks are as

efficient as commercial banks (2009). Although German cooperative banks appear slightly less cost efficient, cooperative banks in France, Italy and Spain are largely more cost

r commercial peers (Ayadi et al., 2010). This confirms findings from owned and cooperative banks are more cost-efficient

Altunbaş et al. (2003) also find a sample study of banks

2000. Savings and cooperative banks were found Country studies, such as

Altunbas et al. (2001) on Germany, Giordano and Lopes (2008) on the Italian cooperative sector, or Ceneboyan (1993) on the US savings and loans sector find similar results. An

mutualize and then merge with large joint-stock nted a joint-stock status,

merged with former public banks to form the backbone of the country’s largest joint-stock banking

exception is Mester (1993) who finds that, on the contrUS savings and loans surveyed in 1988, jointpeers in terms of cost-efficiency.

Alternative banks also perform well in terms of profitability. Again, this is all the moresurprising as they are supposedly less focused on making profits than private banks. Indeed, Berger et al. warn against using profitability measures to compare government banks and private banks because “the measures of performance and economic consequencin these studies do not always correspond to the objectives of the stateet al., 2005). This caveat applies to studies of savings banks and cooperative banks that focus exclusively on profitability and casts doubt on the vaprivate banks with measures drawn from jointor non-profit organizations (such as stock returns used by Cole and Mehran (1998) on a sample of US thrift institutions).

Notwithstanding these problems with using measures of profitability, alternative banks still fare well in recent studies. government-owned banks performed better than privatelythe crisis (pre-crisis performance was at par). Millon Cornett et al. (2010) present mixed evidence on the comparative performance of government banks. Studying a sample of East Asian banks from 1989-2004, the authors find that stateheld less core capital, and had greater credit risk than privately1997 crisis.5 However, East Asian government banks caught up to private bank levels of performance in the years after the crisis. Micco et al. (2007) fdeveloping countries are less profitable than private(2005) find significant difference between state banks and private banks in Eastern Europe in terms of profit efficiency. An earlier compaverage, that state banks posted higher returns on assets than private banks (Molyneux and Thornton, 1992). Aggregate comparisons of public and private banks after the 2007 crisis become difficult because nationalizations or public rescue of

The evidence on profitability in cooperative banks and savings banks is also mixed. Ayadi et al. (2010) find German and Spanish cooperative banks more profitable than commercial banks in terms of returns on assets and returns on equity. However, this does not hold for cooperative banks in other European countries. After excluding small cooperative banks and savings banks, Iannotta et al (2007) find that governmentcooperative banks perform worse than private, commercial banks, both in terms of profitability and riskiness. Altunbas et al. (2003) also find that European commercial banks are slightly more profitable than their noncomparative studies are reversed in several analyses of specific countries: Chakravarty & Williams (2006) on Germany, Crespi et al. (2004) on Spain, Altunbas et al. (2001) on Germany, Valneck (1999) on British building societies and Cebenoyan et al. all find non-profit banks to be more profitable than their for

Finally, results from comparison of risk management in alternative and private banks are also mixed. Standard measures of bank risk (such as zprobabilities, or earnings volatility) produce mixed results. Millon Cornett et al. (2010) and Iannotta et al.

5 However, it should be said tha lower or higher credit risk are affected by risk measurementhemselves associated with bank regulations such as core capital requirements under tha Basle agreements. We thank an anonymous reviewer for pointing that out to us.


17

exception is Mester (1993) who finds that, on the contrary, in a sample of more than a 1,000 US savings and loans surveyed in 1988, joint-stock savings and loans outperform their mutual

efficiency. Alternative banks also perform well in terms of profitability. Again, this is all the more

surprising as they are supposedly less focused on making profits than private banks. Indeed, Berger et al. warn against using profitability measures to compare government banks and

“the measures of performance and economic consequencin these studies do not always correspond to the objectives of the state-owned banks” (Berger et al., 2005). This caveat applies to studies of savings banks and cooperative banks that focus exclusively on profitability and casts doubt on the validity of comparing alternative banks and private banks with measures drawn from joint-stock firms instead of cooperative institutions

profit organizations (such as stock returns used by Cole and Mehran (1998) on a sample of US thrift institutions).

Notwithstanding these problems with using measures of profitability, alternative banks still fare well in recent studies. Dietrich and Wanzenried (2011) find that Swiss

owned banks performed better than privately-owned commercial banks crisis performance was at par). Millon Cornett et al. (2010) present mixed

evidence on the comparative performance of government banks. Studying a sample of East 2004, the authors find that state-owned banks were

held less core capital, and had greater credit risk than privately-owned banks prior to the However, East Asian government banks caught up to private bank levels of

performance in the years after the crisis. Micco et al. (2007) find that statedeveloping countries are less profitable than private-owned banks. However, Bonin et al. (2005) find significant difference between state banks and private banks in Eastern Europe in terms of profit efficiency. An earlier comparison of European banks in the 1980s found, on average, that state banks posted higher returns on assets than private banks (Molyneux and Thornton, 1992). Aggregate comparisons of public and private banks after the 2007 crisis

tionalizations or public rescue of banks undercut this dichotomy.he evidence on profitability in cooperative banks and savings banks is also mixed.

Ayadi et al. (2010) find German and Spanish cooperative banks more profitable than ms of returns on assets and returns on equity. However, this does not

hold for cooperative banks in other European countries. After excluding small cooperative banks and savings banks, Iannotta et al (2007) find that government-owned banks and

banks perform worse than private, commercial banks, both in terms of profitability and riskiness. Altunbas et al. (2003) also find that European commercial banks are slightly more profitable than their non-profit peers. However, these results from

ive studies are reversed in several analyses of specific countries: Chakravarty & Williams (2006) on Germany, Crespi et al. (2004) on Spain, Altunbas et al. (2001) on Germany, Valneck (1999) on British building societies and Cebenoyan et al.

profit banks to be more profitable than their for-profit counterparts.Finally, results from comparison of risk management in alternative and private banks

Standard measures of bank risk (such as z-scores which measure defauprobabilities, or earnings volatility) produce mixed results. Studies by La Porta et al. (2002), Millon Cornett et al. (2010) and Iannotta et al. (2007) find government-owned banks (but not

However, it should be said tha lower or higher credit risk are affected by risk measurementhemselves associated with bank regulations such as core capital requirements under tha Basle agreements. We thank an anonymous reviewer for pointing that out to us.


ary, in a sample of more than a 1,000 stock savings and loans outperform their mutual

Alternative banks also perform well in terms of profitability. Again, this is all the more surprising as they are supposedly less focused on making profits than private banks. Indeed, Berger et al. warn against using profitability measures to compare government banks and

“the measures of performance and economic consequences employed owned banks” (Berger

et al., 2005). This caveat applies to studies of savings banks and cooperative banks that focus lidity of comparing alternative banks and

stock firms instead of cooperative institutions profit organizations (such as stock returns used by Cole and Mehran (1998) on a

Notwithstanding these problems with using measures of profitability, alternative Dietrich and Wanzenried (2011) find that Swiss

owned commercial banks during crisis performance was at par). Millon Cornett et al. (2010) present mixed

evidence on the comparative performance of government banks. Studying a sample of East owned banks were less profitable,

owned banks prior to the However, East Asian government banks caught up to private bank levels of

ind that state-owned banks in owned banks. However, Bonin et al.

(2005) find significant difference between state banks and private banks in Eastern Europe in arison of European banks in the 1980s found, on

average, that state banks posted higher returns on assets than private banks (Molyneux and Thornton, 1992). Aggregate comparisons of public and private banks after the 2007 crisis

banks undercut this dichotomy. he evidence on profitability in cooperative banks and savings banks is also mixed.

Ayadi et al. (2010) find German and Spanish cooperative banks more profitable than ms of returns on assets and returns on equity. However, this does not

hold for cooperative banks in other European countries. After excluding small cooperative owned banks and

banks perform worse than private, commercial banks, both in terms of profitability and riskiness. Altunbas et al. (2003) also find that European commercial banks

profit peers. However, these results from ive studies are reversed in several analyses of specific countries: Chakravarty &

Williams (2006) on Germany, Crespi et al. (2004) on Spain, Altunbas et al. (2001) on Germany, Valneck (1999) on British building societies and Cebenoyan et al. (1993) on the US

profit counterparts. Finally, results from comparison of risk management in alternative and private banks

scores which measure default Studies by La Porta et al. (2002),

owned banks (but not

However, it should be said tha lower or higher credit risk are affected by risk measurement methods, themselves associated with bank regulations such as core capital requirements under tha Basle

cooperative banks in the latter case) to be less stable; while (2009); Beck et al. (2012); Bongini & Ferri (2008); Garcia2008); Cihak and Hesse (2007); Iannotta et al. (2007); Salas and Saurinas (2002); Esty (1997) all report higher earnings stability forBeck et al. (2012); Garcia-Marco and Roblesdefault in cooperative banks and savings banks compared to private banks.

Although rare, comparisons of credit risbanks have lower proportion of nonbanks (Beck et al., 2012; Salas and Saurina, 2002). suggests that levels of non-perfvery high levels under military rule and nonlevels of private banks in the country during democratization in the 2000s (Mettenheim , 2010). Although it is difficult to control for rolling over bad loans, data from the Reserve Bank of India also suggest that the level of nonprivate bank levels during the 2000s (Mettenheim, 2014).

Comparative and statistical analyses thereby support our claim about the realization of competitive advantages by alternative banks based on trends in market shares. liberalization, deregulation and the technology revolution in banking since the 1980s, alternative banks in many countries not only have survived; they have fared well on the basis of standard indicators of performance in comparisons with formore adequate measures to assess alternative bank performance (such as counterlending or credit rationing) may produce findings more clearly favouring these institutions over private banks (Schclarek-Curutchet, 2014).of bank profitability, efficiency and risk management from the literatureAnd the evidence clearly suggests that alternative banks compare well with private banks using these measures.

Before turning to banking theory and heterodox theories of institutional foundations of competitive advantage for explanathan private banks, clarification of why alternative banks matter is in order.

4 Why alternative banks matter

Alternative banks matter because they counter the credit rationing of private banks (Bret al, 2007) and capital drain (Hakenes and Schnabel, 2006), and promote financial inclusion by reaching downmarket to the underserved poor and geographically isolated citizens that private banks have increasingly refused to retain as clients (FederCorporation, 2012). Alternative banks also provide important options for social and political forces and can reduce the cost of public policy (banks multiply money, after all), while increasing contractual control over policy implement

4.1 Alternative banks as institutions for social and economic development

A first obvious reason for alternative banks to exist is that they perform specific roles in an economy. In particular, two specific functions fulfilled by alternative ban

6 Whether this provides tough tests that indicate competitive advantages in altinstead, that alternative measures and alternative theories are needed is a question we return to below


18

cooperative banks in the latter case) to be less stable; while Ayadi et al. (2010); Ayadi et al. (2009); Beck et al. (2012); Bongini & Ferri (2008); Garcia-Marco and Robles2008); Cihak and Hesse (2007); Iannotta et al. (2007); Salas and Saurinas (2002); Esty (1997) all report higher earnings stability for cooperative and savings banks. Ayadi et al. (2009);

Marco and Robles-Fernandez (2008) find lower probabilities of default in cooperative banks and savings banks compared to private banks.

Although rare, comparisons of credit risk find that cooperative banks and savings banks have lower proportion of non-performing loans in their loan portfolio than commercial

., 2012; Salas and Saurina, 2002). Data from the Central Bank of Brazil performing loans in Brazilian government banks have fallen from

very high levels under military rule and non-democratic transition governments to well below levels of private banks in the country during democratization in the 2000s (Mettenheim ,

h it is difficult to control for rolling over bad loans, data from the Reserve Bank of India also suggest that the level of non-performing loans at state banks has converged to private bank levels during the 2000s (Mettenheim, 2014).

tical analyses thereby support our claim about the realization of competitive advantages by alternative banks based on trends in market shares. liberalization, deregulation and the technology revolution in banking since the 1980s,

in many countries not only have survived; they have fared well on the basis of standard indicators of performance in comparisons with for-profit private banks. Using more adequate measures to assess alternative bank performance (such as counterending or credit rationing) may produce findings more clearly favouring these institutions

Curutchet, 2014). However, to date, most studies use measures of bank profitability, efficiency and risk management from the literature on private banking.And the evidence clearly suggests that alternative banks compare well with private banks

Before turning to banking theory and heterodox theories of institutional foundations of competitive advantage for explanation of why alternative banks perform as well or better than private banks, clarification of why alternative banks matter is in order.

4 Why alternative banks matter

Alternative banks matter because they counter the credit rationing of private banks (Bret al, 2007) and capital drain (Hakenes and Schnabel, 2006), and promote financial inclusion by reaching downmarket to the underserved poor and geographically isolated citizens that private banks have increasingly refused to retain as clients (Federal Deposit Insurance Corporation, 2012). Alternative banks also provide important options for social and political forces and can reduce the cost of public policy (banks multiply money, after all), while increasing contractual control over policy implementation.


A first obvious reason for alternative banks to exist is that they perform specific roles in an economy. In particular, two specific functions fulfilled by alternative banks stand out for their

Whether this provides tough tests that indicate competitive advantages in alternative banking or, instead, that alternative measures and alternative theories are needed is a question we return to


Ayadi et al. (2010); Ayadi et al. Marco and Robles-Fernandez (

2008); Cihak and Hesse (2007); Iannotta et al. (2007); Salas and Saurinas (2002); Esty (1997) cooperative and savings banks. Ayadi et al. (2009);

Fernandez (2008) find lower probabilities of default in cooperative banks and savings banks compared to private banks.

k find that cooperative banks and savings performing loans in their loan portfolio than commercial

Data from the Central Bank of Brazil orming loans in Brazilian government banks have fallen from

democratic transition governments to well below levels of private banks in the country during democratization in the 2000s (Mettenheim ,

h it is difficult to control for rolling over bad loans, data from the Reserve Bank performing loans at state banks has converged to

tical analyses thereby support our claim about the realization of competitive advantages by alternative banks based on trends in market shares. Despite liberalization, deregulation and the technology revolution in banking since the 1980s,

in many countries not only have survived; they have fared well on the basis profit private banks. Using

more adequate measures to assess alternative bank performance (such as counter-cyclical ending or credit rationing) may produce findings more clearly favouring these institutions

However, to date, most studies use measures on private banking.6

And the evidence clearly suggests that alternative banks compare well with private banks

Before turning to banking theory and heterodox theories of institutional foundations of tion of why alternative banks perform as well or better

than private banks, clarification of why alternative banks matter is in order.

Alternative banks matter because they counter the credit rationing of private banks (Bresler et al, 2007) and capital drain (Hakenes and Schnabel, 2006), and promote financial inclusion by reaching downmarket to the underserved poor and geographically isolated citizens that

al Deposit Insurance Corporation, 2012). Alternative banks also provide important options for social and political forces and can reduce the cost of public policy (banks multiply money, after all), while


A first obvious reason for alternative banks to exist is that they perform specific roles in an ks stand out for their

ernative banking or, instead, that alternative measures and alternative theories are needed is a question we return to

importance for social and economic development: enlarging access to banking services and funding economic development.

Regarding the first function, the core mission given to cooperative and savings banks at their inception, in the 19th century, was precisely to address, respectively, the financing and liquidity of their low and middlethe working classes. These two types of banks retain a specialization in retail lending (lendito households and small firms) and collecting deposits from low and middlehouseholds.

Secondly, cooperative and savings banks have also played a key role in channeling funds to government securities and funding house ownership in several Europethroughout the 20th century. In many advanced industrial and emerging economies, public development banks obviously have as an explicit mandate the duty to finance a broad array of general interest projects, ranging from funding small and medihousing and local economic development.

4.2 Alternative banks as buffer for systemic stability

An equally important argument in support of alternative banks concerns their impact on the overall functioning of the financial syof an emerging literature on banking diversity. This literature develops three broad arguments.

The first argument simply consists in acknowledging, on the one hand, the existing diversity of banking business models across and within national banking systems; and, on the other hand, the fact that these different business models are not equally performing in terms of efficiency, profitability and risk. Such an argument can be found in the empiricalliterature on alternative banks, cited above. It also appears in official government reports, such as the UK Treasury report on financial regulation (HM Treasury, 2010); or the Liikanen Report for the European Commission that stresses six types oownership, capital and funding, activities revealed by balance sheets and income statements, corporate and legal structure, and geographical scope) (Liiikanen, 2012). Michie and Oughton (2013) suggest measuring bank diversity sheet resilience, and geographical spread.

The second argument is that diversity is valuable in itself, as a characteristic of the banking sector as a whole. In other words, a banking system composed of heorganizations does better at mitigating systemic risk than a homogeneous banking system, whatever the source of heterogeneity. This point is very similar to the view that homogeneous banking systems suffer from a tooregulators “induces banks to herd out” ex-post (Acharya and Yorulmazer, 2007). More broadly, risk in banking by reducing thecaused by the fact that all banks specialized in the same asset class (say, mortgage assets) rather, it was caused by the high level of correlation between banks. As Haldane (2009) famously lead to a decrease of systemic diversity andbut related argument: The homogenization of banking systems reduced share risk and operated through the rethe banking system (Wagner, 2010; Wagner,


19

importance for social and economic development: enlarging access to banking services and funding economic development.

Regarding the first function, the core mission given to cooperative and savings banks at century, was precisely to address, respectively, the financing and

liquidity of their low and middle-income members and the need to encourage the deposits of the working classes. These two types of banks retain a specialization in retail lending (lendito households and small firms) and collecting deposits from low and middle

Secondly, cooperative and savings banks have also played a key role in channeling funds to government securities and funding house ownership in several Europe

century. In many advanced industrial and emerging economies, public development banks obviously have as an explicit mandate the duty to finance a broad array of general interest projects, ranging from funding small and medium firms to financing social housing and local economic development.

4.2 Alternative banks as buffer for systemic stability

An equally important argument in support of alternative banks concerns their impact on the overall functioning of the financial system, including systemic stability. This issue is the object of an emerging literature on banking diversity. This literature develops three broad

The first argument simply consists in acknowledging, on the one hand, the existing king business models across and within national banking systems; and, on the

other hand, the fact that these different business models are not equally performing in terms of efficiency, profitability and risk. Such an argument can be found in the empiricalliterature on alternative banks, cited above. It also appears in official government reports, such as the UK Treasury report on financial regulation (HM Treasury, 2010); or the Liikanen Report for the European Commission that stresses six types of diversity in banking (size, ownership, capital and funding, activities revealed by balance sheets and income statements, corporate and legal structure, and geographical scope) (Liiikanen, 2012). Michie and Oughton (2013) suggest measuring bank diversity on the basis of ownership, competitionsheet resilience, and geographical spread.

The second argument is that diversity is valuable in itself, as a characteristic of the . In other words, a banking system composed of he

organizations does better at mitigating systemic risk than a homogeneous banking system, whatever the source of heterogeneity. This point is very similar to the view that homogeneous banking systems suffer from a too-many-to-fail problem, whereby an implicit guarantee by

induces banks to herd ex-ante in order to increase the likelihood of being bailed Yorulmazer, 2007). More broadly, diversity helps

reducing the similarity of bank portfolios. Indeed, the 2007caused by the fact that all banks specialized in the same asset class (say, mortgage assets) rather, it was caused by the high level of correlation between the diversification strategies

(2009) famously pointed out, individual diversification by banks might lead to a decrease of systemic diversity and increase systemic risk. Wagner makes

he homogenization of banking systems reduced the ability ofthrough the re-optimization of bank portfolios to

2010; Wagner, 2010; Goodhart and Wagner, 2012). This


importance for social and economic development: enlarging access to banking services and

Regarding the first function, the core mission given to cooperative and savings banks at century, was precisely to address, respectively, the financing and

income members and the need to encourage the deposits of the working classes. These two types of banks retain a specialization in retail lending (lending to households and small firms) and collecting deposits from low and middle-income

Secondly, cooperative and savings banks have also played a key role in channeling funds to government securities and funding house ownership in several European countries

century. In many advanced industrial and emerging economies, public development banks obviously have as an explicit mandate the duty to finance a broad array of

um firms to financing social

An equally important argument in support of alternative banks concerns their impact on the stem, including systemic stability. This issue is the object

of an emerging literature on banking diversity. This literature develops three broad

The first argument simply consists in acknowledging, on the one hand, the existing king business models across and within national banking systems; and, on the

other hand, the fact that these different business models are not equally performing in terms of efficiency, profitability and risk. Such an argument can be found in the empirical academic literature on alternative banks, cited above. It also appears in official government reports, such as the UK Treasury report on financial regulation (HM Treasury, 2010); or the Liikanen

f diversity in banking (size, ownership, capital and funding, activities revealed by balance sheets and income statements, corporate and legal structure, and geographical scope) (Liiikanen, 2012). Michie and Oughton

ownership, competition, balance

The second argument is that diversity is valuable in itself, as a characteristic of the . In other words, a banking system composed of heterogeneous

organizations does better at mitigating systemic risk than a homogeneous banking system, whatever the source of heterogeneity. This point is very similar to the view that homogeneous

by an implicit guarantee by in order to increase the likelihood of being bailed

helps reduce systemic bank portfolios. Indeed, the 2007-8 crisis was not

caused by the fact that all banks specialized in the same asset class (say, mortgage assets) – diversification strategies of

pointed out, individual diversification by banks might Wagner makes a different

the ability of banks to to disrupt liquidity in

Goodhart and Wagner, 2012). This

argument lies at the core of the diversity literature, since it goes or type of organizational forms to

A third argument about diversity is that it is important for the evolution of banking systems. For Michie (2011), “In a situation of uncertknow which model will prove to be superior in all possible future circumstances, so we ought to be rather cautious before destroying any successful modelbanking diversity do not imply to the view that the existence of alternative banks has a positive impact on financial systems as a whole – especially as lower diversification and smaller size economic conditions (De Jonghe, 2010; Vallascas and Keasey, 2012).


Contemporary banking theory, as pres(Berger et al., 2010), or in textbooks (Matthews and Thompson, 2008), provide scant reference to savings banks, cooperative banks or government banks. None of the 36 chapters of the 2010 Handbook deal with notoriented banks. Indeed, savings banks and mutual banks are absent from the cooperative banks appears twice (in a chapter on Japan); development banks once (under the heading Development Bank of Japan in the same chapter); thrift institutions twice in a chapter on the US alongside a single entry on thrift failures; and statetimes in a chapter on transition countries. Ignoring alternative banks in a handbothree years after the 2007-8 financial crisis indicates the attitude of mainstream banking studies. However, heterodox theories of banking seem to share the same apparent lack of interest in alternative banks (Nasica, 2010; Bertocco, 2006), evanalysis is to fundamentally reassess what banks should do (Wray, 2013). While economists in the past paid more attention to nonexclusively on governance and ownership

To redress this lacuna about alternative banking and bring out implications for contemporary banking theory, we turn to previous research about nonintermediaries. A note on banking theory is in order to explain this strategy. Insense, modern theories of banking emerged in the 1960s in reaction to the “pure theory of fractional reserve banking” (Towey, 1974). Neobanking were primarily theories of money. From this perspective, bamonetary authorities and cogs in the money multiplier: Banks were seen purely as money creating entities, with no relevant contribution to the economy. New views of banking (Tobin, 1963; Gurley and Shaw, 1960) focused on two charactcalled the mystique of money. From the borrowers point of view, Tobin argued that substitutability between financial assets required the rejection of money as special. Second, Tobin and others argued that banks arecreated ‘money’ is a liability, which must be matched on the other side of the balance sheet. And banks, as businesses, must earn money from their middleman’s role” (Tobin, 1963: 416).

7 A previous version of the argument made in the following two section is found in Butzbach and Mettenheim, 2014. 8 As Rasmussen put it 25 years ago: “the difference between mutual and stock banks lies in who controls the bank and receives the profits” (Rasmussen, 1988: 395).


20

argument lies at the core of the diversity literature, since it goes beyond the specific identity or type of organizational forms to stress the importance of broader forms

about diversity is that it is important for the evolution of banking “In a situation of uncertainty and unpredictability, we cannot

know which model will prove to be superior in all possible future circumstances, so we ought to be rather cautious before destroying any successful model.” Although arguments about

do not imply full support for alternative banks per se, they to the view that the existence of alternative banks has a positive impact on

especially because the characteristics of alternative banks such smaller size may allow them to better withstand adverse

economic conditions (De Jonghe, 2010; Vallascas and Keasey, 2012).


Contemporary banking theory, as presented, for instance, in the Oxford Handbook of Banking(Berger et al., 2010), or in textbooks (Matthews and Thompson, 2008), provide scant reference to savings banks, cooperative banks or government banks. None of the 36 chapters

with not-for-profit financial intermediaries or stakeholderoriented banks. Indeed, savings banks and mutual banks are absent from the cooperative banks appears twice (in a chapter on Japan); development banks once (under the

pment Bank of Japan in the same chapter); thrift institutions twice in a chapter on the US alongside a single entry on thrift failures; and state-owned commercial banks four times in a chapter on transition countries. Ignoring alternative banks in a handbo

8 financial crisis indicates the attitude of mainstream banking studies. However, heterodox theories of banking seem to share the same apparent lack of interest in alternative banks (Nasica, 2010; Bertocco, 2006), even when the stated purpose of analysis is to fundamentally reassess what banks should do (Wray, 2013). While economists in the past paid more attention to non-profit financial intermediaries, research focused almost exclusively on governance and ownership issues.8

To redress this lacuna about alternative banking and bring out implications for contemporary banking theory, we turn to previous research about non-profit financial intermediaries. A note on banking theory is in order to explain this strategy. Insense, modern theories of banking emerged in the 1960s in reaction to the “pure theory of fractional reserve banking” (Towey, 1974). Neo-classical theories of fractional reserve banking were primarily theories of money. From this perspective, banks remained sideman to monetary authorities and cogs in the money multiplier: Banks were seen purely as money creating entities, with no relevant contribution to the economy. New views of banking (Tobin, 1963; Gurley and Shaw, 1960) focused on two characteristics. First, they rejected what Tobin called the mystique of money. From the borrowers point of view, Tobin argued that substitutability between financial assets required the rejection of money as special. Second, Tobin and others argued that banks are firms with specific corporate goals. For Tcreated ‘money’ is a liability, which must be matched on the other side of the balance sheet. And banks, as businesses, must earn money from their middleman’s role” (Tobin, 1963: 416).

A previous version of the argument made in the following two section is found in Butzbach and

t it 25 years ago: “the difference between mutual and stock banks lies in who controls the bank and receives the profits” (Rasmussen, 1988: 395).


beyond the specific identity s of diversity.

about diversity is that it is important for the evolution of banking ainty and unpredictability, we cannot

know which model will prove to be superior in all possible future circumstances, so we ought arguments about

they do lend support to the view that the existence of alternative banks has a positive impact on banking and

of alternative banks such allow them to better withstand adverse

5 Explaining competitive advantages of alternative banks with banking theory7

Oxford Handbook of Banking (Berger et al., 2010), or in textbooks (Matthews and Thompson, 2008), provide scant reference to savings banks, cooperative banks or government banks. None of the 36 chapters

profit financial intermediaries or stakeholder-oriented banks. Indeed, savings banks and mutual banks are absent from the Handbook index; cooperative banks appears twice (in a chapter on Japan); development banks once (under the

pment Bank of Japan in the same chapter); thrift institutions twice in a chapter owned commercial banks four

times in a chapter on transition countries. Ignoring alternative banks in a handbook published 8 financial crisis indicates the attitude of mainstream banking

studies. However, heterodox theories of banking seem to share the same apparent lack of en when the stated purpose of

analysis is to fundamentally reassess what banks should do (Wray, 2013). While economists profit financial intermediaries, research focused almost

To redress this lacuna about alternative banking and bring out implications for profit financial

intermediaries. A note on banking theory is in order to explain this strategy. In a broader sense, modern theories of banking emerged in the 1960s in reaction to the “pure theory of

classical theories of fractional reserve nks remained sideman to

monetary authorities and cogs in the money multiplier: Banks were seen purely as money creating entities, with no relevant contribution to the economy. New views of banking (Tobin,

eristics. First, they rejected what Tobin called the mystique of money. From the borrowers point of view, Tobin argued that substitutability between financial assets required the rejection of money as special. Second,

firms with specific corporate goals. For Tobin, “Bank-created ‘money’ is a liability, which must be matched on the other side of the balance sheet. And banks, as businesses, must earn money from their middleman’s role” (Tobin, 1963: 416).

A previous version of the argument made in the following two section is found in Butzbach and

t it 25 years ago: “the difference between mutual and stock banks lies in who

Modern theories of banking demonstrated that bank managers strategies to maximize returns from lending and interest rates on deposits (Tobin, 1982; Santomero, 1984); and that lending is determined by the marginal returns of assets over the cost of liabilities (Klein, 1971). The new theories of banking from Tobin and Gurley and Shaw sought to reinstate a more realistic view of banking within monetary theorybanks per se. Banking theory therefore developed as a secondary argument, following two parallel theoretical tracks. First, while unequally rooted in the neowas a Keynesian and his monetary theory was neothe hypotheses and assumptions of neothe pursuance of self interest as the defining characteristics of individual behavior) and financial institutions. Second, subsequent theories of banking sought tbehavior of banking firms as functions in a financial system of a moneyTobin, of course, focused on the not strictly monetary financial intermediaries […] is to satisfy simultaneously of individuals or firms” (1963: 411).

This dual track in the development of banking theory (mainstream firm theory and a focus on the specific functions of banks) characterizes the bulk of research since 1980a; Diamond and Dybvig, 1983; Baltensperger, 1980; Wray, 2013). A widespread consensus among financial economists holds that banks are multiBhattacharya and Thakor (1993), banks fulfill two key functions in modern financial systems: Banks provide brokerage services and permit asset transformation is a core concept in contemporary theories of banking as financial intermediation. In a nutshell, it means that bank loans retain different risk pliabilities issued by banks to make those loans (Diamond and Rajan, 2001). Recent reviews of research on banking emphasize new trends such as the shift from relational to transactional views of banking (Boot and Marinč, 2008) and the integration of banks and markThakor, 2010) that remain consistent with the functions of brokerage and asset transformation.9

The recent focus on information asymmetries differs from previous views of banking in the 1960s and 1970s. The theory of information asymmetries theories of financial intermediation from the earlier transaction costs2000: 8). From this perspective, banks exist because inability of market-mediated mechanisms to efinherent to financial transactions (Bhattacharya and Thakor, 1993: 14). banks, in other words, lies in the type of contractual mechanism used to solve informational asymmetries. While for Tobin (1963; 1982), banks helped decrease transaction costs through the pooling of risk, modern theories insist on the informational advantages of banks over markets as critical to reduce credit rationing (Stiglitz and Weiss, 1981). Banks are thereby seen to act as delegated monitors to reduce the cost of monitoring borrowers incurred by lenders/depositors (Diamond, 1984). Banks undertake relationship lending to decrease information asymmetries and avert the consequences of information asymmetries on credit relationships: adverse selection and moral hazard (Boot, 2000; Petersen and Rajan, 1994).

9 However, in analyzing this shift in behavior economists ignore the important role of topregulatory reforms and changes in accounting standards. Thanks to an anonymous referee for this useful comment.


21

of banking demonstrated that bank assets and liabilities were determined by bank managers strategies to maximize returns from lending and interest rates on deposits (Tobin, 1982; Santomero, 1984); and that lending is determined by the marginal returns of assets over the cost of liabilities (Klein, 1971).

The new theories of banking from Tobin and Gurley and Shaw sought to reinstate a within monetary theory, not to offer a better understanding of

therefore developed as a secondary argument, following two parallel theoretical tracks. First, while unequally rooted in the neo-classical tradition (Tobin was a Keynesian and his monetary theory was neo-Keynesian), new views of banking applied

eses and assumptions of neo-classical theories of the firm (utility maximization and the pursuance of self interest as the defining characteristics of individual behavior)

. Second, subsequent theories of banking sought tbehavior of banking firms as functions in a financial system of a money-based economy. Tobin, of course, focused on the not strictly monetary role of banks: “the essential function of financial intermediaries […] is to satisfy simultaneously the portfolio preferences of two types of individuals or firms” (1963: 411).

This dual track in the development of banking theory (mainstream firm theory and a focus on the specific functions of banks) characterizes the bulk of research since

0a; Diamond and Dybvig, 1983; Baltensperger, 1980; Wray, 2013). A widespread consensus among financial economists holds that banks are multi-function firms. For Bhattacharya and Thakor (1993), banks fulfill two key functions in modern financial systems:

nks provide brokerage services and permit qualitative asset transformation. asset transformation is a core concept in contemporary theories of banking as financial intermediation. In a nutshell, it means that bank loans retain different risk p

ties issued by banks to make those loans (Diamond and Rajan, 2001). Recent reviews of research on banking emphasize new trends such as the shift from relational to transactional views of banking (Boot and Marinč, 2008) and the integration of banks and markThakor, 2010) that remain consistent with the functions of brokerage and asset

The recent focus on information asymmetries differs from previous views of banking in the 1960s and 1970s. The theory of information asymmetries helps distinguish “modern theories of financial intermediation from the earlier transaction costs-based theories” (Boot, 2000: 8). From this perspective, banks exist because “intermediation is a response to the

mediated mechanisms to efficiently resolve informational problems” inherent to financial transactions (Bhattacharya and Thakor, 1993: 14). The specificity of banks, in other words, lies in the type of contractual mechanism used to solve informational

(1963; 1982), banks helped decrease transaction costs through the pooling of risk, modern theories insist on the informational advantages of banks over markets as critical to reduce credit rationing (Stiglitz and Weiss, 1981). Banks are thereby

as delegated monitors to reduce the cost of monitoring borrowers incurred by (Diamond, 1984). Banks undertake relationship lending to decrease

information asymmetries and avert the consequences of information asymmetries on credit tionships: adverse selection and moral hazard (Boot, 2000; Petersen and Rajan, 1994).

However, in analyzing this shift in behavior economists ignore the important role of toporms and changes in accounting standards. Thanks to an anonymous referee for this


bank assets and liabilities were determined by bank managers strategies to maximize returns from lending and interest rates on deposits (Tobin, 1982; Santomero, 1984); and that lending is determined by the marginal returns of

The new theories of banking from Tobin and Gurley and Shaw sought to reinstate a , not to offer a better understanding of

therefore developed as a secondary argument, following two classical tradition (Tobin

Keynesian), new views of banking applied classical theories of the firm (utility maximization and

the pursuance of self interest as the defining characteristics of individual behavior) to banks . Second, subsequent theories of banking sought to explain the

based economy. role of banks: “the essential function of

the portfolio preferences of two types

This dual track in the development of banking theory (mainstream firm theory and a focus on the specific functions of banks) characterizes the bulk of research since (Fama,

0a; Diamond and Dybvig, 1983; Baltensperger, 1980; Wray, 2013). A widespread function firms. For

Bhattacharya and Thakor (1993), banks fulfill two key functions in modern financial systems: qualitative asset transformation. Qualitative

asset transformation is a core concept in contemporary theories of banking as financial intermediation. In a nutshell, it means that bank loans retain different risk profiles than the

ties issued by banks to make those loans (Diamond and Rajan, 2001). Recent reviews of research on banking emphasize new trends such as the shift from relational to transactional views of banking (Boot and Marinč, 2008) and the integration of banks and markets (Boot and Thakor, 2010) that remain consistent with the functions of brokerage and asset

The recent focus on information asymmetries differs from previous views of banking in helps distinguish “modern

based theories” (Boot, “intermediation is a response to the

ficiently resolve informational problems” The specificity of

banks, in other words, lies in the type of contractual mechanism used to solve informational (1963; 1982), banks helped decrease transaction costs through

the pooling of risk, modern theories insist on the informational advantages of banks over markets as critical to reduce credit rationing (Stiglitz and Weiss, 1981). Banks are thereby

as delegated monitors to reduce the cost of monitoring borrowers incurred by (Diamond, 1984). Banks undertake relationship lending to decrease

information asymmetries and avert the consequences of information asymmetries on credit tionships: adverse selection and moral hazard (Boot, 2000; Petersen and Rajan, 1994).

However, in analyzing this shift in behavior economists ignore the important role of top-down orms and changes in accounting standards. Thanks to an anonymous referee for this

However, the profound advances in banking theory in the last decades cannot dispel the notion that organizational aspects of bankingContemporary banking studies parallel developments in neo-institutional economic theories of the firm (agency theory and property rights theory). The following sections therefore first draw on advantages of alternative banks, as banks. We then turn to more promising heterodox views of how firms acquire and maintain institutional foundations of competitive advantage for further, more complete explanations more promising prospects for the development of alternative banking theory.

5.1 Alternative banking and agency theory

Comparisons of bank performance are often informed by concepts and measures ftheory. Within this framework, the efficiency of banking firms turns on their ability to mitigate potential agency conflicts. Again, mainstream theories of the firm form the explicit (Fama, 1980a; 1980b) or implicit underpinning of most of new temerged since the 1960s. To take a notable example, the intuition behind seeing banks as delegated monitors (Diamond, 1984) comes from the assumption that banks are able to reduce the cost of monitoring borrowers that typical agency cost in financial markets. In another example, the large body of comparative empirical work on bank shareholding structure in the 1990s (that provides the terms for current stakeholder versus shareholder dtheory (Altunbas et al., 2003). Indeed, the choice of the terms “stakeholder“shareholder-oriented” (Coco and Ferri, 2010) to compare banks suggests the primacy of governance and ownership issues in this literature.

This dichotomy between stakeholderquestionable per se. What is debatable, instead, is both (i) the explicit or implicit adherence to mainstream neo-classical theories of the firm of advantages of public or mutual versus private ownership; (ii) the implicit assumption that ownership and governance are the key characteristics that distinguish alternative banks from private banks, an assumption that ignnext section).

Regarding the first point, a brief review of basic tenets of agency theory in comparative theories of banking organizations is in order. Of course, economic thinking about non jointstock forms of economic organization has evolved since the rapid dismissal of mutual firms as more conducive to shirking by managers by Alchian and Demsetz (1972).agency theory and property rights theory (often associated in modern theories owere set by Alchian and Demsetz (1972; 1973) and Jensen and Meckling (1976). The whole edifice built on these foundations (Fama, 1980b; Fama and Jensen, 1983a and 1983b; Hart and Moore, 1990) shares the same basic premises, especially the assuorganizational forms are better than others in reducing transaction costs. Alchian and Demsetz saw the constitution of the modern firm as the solution to the problems of

10 This all boils down to the absence of shareholders in mutuals, according to Alchian and Demsetz: “In nonprofit corporations, [...] the future consequences opresent wealth of stockholders. [...] One should, therefore, find greater shirking in nonprofit, mutually owned enterprises.” (Alchian and Demsetz, 1972, p.790).


22

However, the profound advances in banking theory in the last decades cannot dispel organizational aspects of banking remain ignored or underestimated.

ontemporary banking studies rely on a default theory of the modern firminstitutional economic theories of the firm (agency theory and

The following sections therefore first draw on agency theory to explain the competitive advantages of alternative banks, as banks. We then turn to more promising heterodox views of how firms acquire and maintain institutional foundations of competitive advantage for further, more complete explanations of recent empirical findings about alternative banks and more promising prospects for the development of alternative banking theory.

Alternative banking and agency theory

Comparisons of bank performance are often informed by concepts and measures ftheory. Within this framework, the efficiency of banking firms turns on their ability to mitigate potential agency conflicts. Again, mainstream theories of the firm form the explicit (Fama, 1980a; 1980b) or implicit underpinning of most of new theories of banking that have emerged since the 1960s. To take a notable example, the intuition behind seeing banks as delegated monitors (Diamond, 1984) comes from the assumption that banks are able to reduce the cost of monitoring borrowers that investors face on credit markets. typical agency cost in financial markets. In another example, the large body of comparative empirical work on bank shareholding structure in the 1990s (that provides the terms for current stakeholder versus shareholder debate about banking), made extensive use of agency

). Indeed, the choice of the terms “stakeholderoriented” (Coco and Ferri, 2010) to compare banks suggests the primacy of

ssues in this literature. This dichotomy between stakeholder- and shareholder-governance in banking is not

. What is debatable, instead, is both (i) the explicit or implicit adherence to classical theories of the firm of most works discussing the relative

advantages of public or mutual versus private ownership; (ii) the implicit assumption that ownership and governance are the key characteristics that distinguish alternative banks from private banks, an assumption that ignores other factors of differentiation (discussed in the

Regarding the first point, a brief review of basic tenets of agency theory in comparative theories of banking organizations is in order. Of course, economic thinking about non joint

ock forms of economic organization has evolved since the rapid dismissal of mutual firms as more conducive to shirking by managers by Alchian and Demsetz (1972).agency theory and property rights theory (often associated in modern theories owere set by Alchian and Demsetz (1972; 1973) and Jensen and Meckling (1976). The whole edifice built on these foundations (Fama, 1980b; Fama and Jensen, 1983a and 1983b; Hart and Moore, 1990) shares the same basic premises, especially the assumption that certain organizational forms are better than others in reducing transaction costs. Alchian and Demsetz saw the constitution of the modern firm as the solution to the problems of

This all boils down to the absence of shareholders in mutuals, according to Alchian and Demsetz: “In nonprofit corporations, [...] the future consequences of improved management are not capitalized into present wealth of stockholders. [...] One should, therefore, find greater shirking in nonprofit, mutually owned enterprises.” (Alchian and Demsetz, 1972, p.790).


However, the profound advances in banking theory in the last decades cannot dispel remain ignored or underestimated.

rely on a default theory of the modern firm, mostly based on institutional economic theories of the firm (agency theory and

agency theory to explain the competitive advantages of alternative banks, as banks. We then turn to more promising heterodox views of how firms acquire and maintain institutional foundations of competitive advantage for

of recent empirical findings about alternative banks and more promising prospects for the development of alternative banking theory.

Comparisons of bank performance are often informed by concepts and measures from agency theory. Within this framework, the efficiency of banking firms turns on their ability to mitigate potential agency conflicts. Again, mainstream theories of the firm form the explicit

heories of banking that have emerged since the 1960s. To take a notable example, the intuition behind seeing banks as delegated monitors (Diamond, 1984) comes from the assumption that banks are able to

face on credit markets. This is a typical agency cost in financial markets. In another example, the large body of comparative empirical work on bank shareholding structure in the 1990s (that provides the terms for

ebate about banking), made extensive use of agency ). Indeed, the choice of the terms “stakeholder-oriented” and

oriented” (Coco and Ferri, 2010) to compare banks suggests the primacy of

governance in banking is not . What is debatable, instead, is both (i) the explicit or implicit adherence to

most works discussing the relative advantages of public or mutual versus private ownership; (ii) the implicit assumption that ownership and governance are the key characteristics that distinguish alternative banks from

ores other factors of differentiation (discussed in the

Regarding the first point, a brief review of basic tenets of agency theory in comparative theories of banking organizations is in order. Of course, economic thinking about non joint-

ock forms of economic organization has evolved since the rapid dismissal of mutual firms as more conducive to shirking by managers by Alchian and Demsetz (1972).10 The bases of agency theory and property rights theory (often associated in modern theories of the firm) were set by Alchian and Demsetz (1972; 1973) and Jensen and Meckling (1976). The whole edifice built on these foundations (Fama, 1980b; Fama and Jensen, 1983a and 1983b; Hart

mption that certain organizational forms are better than others in reducing transaction costs. Alchian and Demsetz saw the constitution of the modern firm as the solution to the problems of

This all boils down to the absence of shareholders in mutuals, according to Alchian and Demsetz: “In f improved management are not capitalized into

present wealth of stockholders. [...] One should, therefore, find greater shirking in nonprofit, mutually

measurement of marginal productivity in the context of team producthe need to monitor team member behavior, but the difficulty both in assessing individual behavior (given information asymmetries and cognitive limitations) and choosing the right monitor (and problems in monitoring the monitor), eresidual risk; the residual claimant, a.k.a. the stock1983b). Herein lies the superiority of shareholderpredict convergence, over time, of form (La Porta et al., 2002; Hansmann and Kraakman, 2000).

In sum, private ownership and shareholderto manage the multiple agency problems of modern firms whseparate. However, agency problems Building on Cuevas and Fischer (2007), Table 5 in the appendix summarizes the likelihood and level of agency costs across three types of banprivate). We also show that monitoring mechanisms differ across bank categories between the two broad bank categories we brought together under the larger umbrella of alternative banks: cooperative banks and publcategories overall agency costs are lower than those sustained in for profit, shareholderbanks.

5.2 Manager-shareholder agency conflicts

A key agency conflict arose from the separation of management frMeans, 1932). Recent theories of the firm emphasize the ability of managers to engage in rentseeking and expense-preference behavior (Fama and Jensen, 1980b; Hart and Moore, 1990). From this perspective, the diffusion of shareholdiinterests; this increases agency costs. Indeed, monitoring and controlling managers and designing incentives to align the interests of shareholders and managers can be very costly. Another source of managerial autonoas the availability of free or uncommitted funds increase, managers will invest in unprofitable projects (Jensen and Meckling, 1976). As table 4.1 shows, three broad categories of banks (cooperative, public and private) each face a slightly different version of the owneragency conflict. However, we argue that agency costs are likely to be lower for both alternative banks in comparison to jointopportunism of managers in joint stock firms may help explain the rapid growth of mutual forms of banking organizations in the 19mutual banks (Rasmussen, 1988), Mayers and Smith for mutual insurance firms (MaySmith, 1994), LaPorta et al., in their work on government banks (La Porta et al., 2002) argue precisely the opposite.

The mainstream argument that favours joint stock ownership and shareholder governance runs as follows (Ayadi et al, 2010): (i) stakeautonomous managers than shareholderstakeholder-based banks cannot rely on market mechanisms to reduce agency costs; and (iii) stakeholder-based banks cannot reduce agency cjoint-stock companies, such as stock options and other schemes linking pay to performance. The question of manager autonomy at alternative banks is complex. According to modern agency theory, diffuse ownership


23

measurement of marginal productivity in the context of team production (1972; 1973). the need to monitor team member behavior, but the difficulty both in assessing individual behavior (given information asymmetries and cognitive limitations) and choosing the right monitor (and problems in monitoring the monitor), early theorists focused on the bearer of residual risk; the residual claimant, a.k.a. the stock-holder (Fama and Jensen, 1983a and

Herein lies the superiority of shareholder-based firm governance, leading some to predict convergence, over time, of all organizations towards this particular organizational form (La Porta et al., 2002; Hansmann and Kraakman, 2000).

In sum, private ownership and shareholder-based governance are seen as better able to manage the multiple agency problems of modern firms where ownership and control are separate. However, agency problems differ across governance and ownership structures. Building on Cuevas and Fischer (2007), Table 5 in the appendix summarizes the likelihood and level of agency costs across three types of bank ownership (cooperative, public and private). We also show that monitoring mechanisms differ across bank categories between the two broad bank categories we brought together under the larger umbrella of alternative banks: cooperative banks and public banks. However, we argue here that in both categories overall agency costs are lower than those sustained in for profit, shareholder

shareholder agency conflicts

A key agency conflict arose from the separation of management from ownership (Berle and Means, 1932). Recent theories of the firm emphasize the ability of managers to engage in rent

preference behavior (Fama and Jensen, 1980b; Hart and Moore, 1990). From this perspective, the diffusion of shareholding enables managers to pursue their own interests; this increases agency costs. Indeed, monitoring and controlling managers and designing incentives to align the interests of shareholders and managers can be very costly. Another source of managerial autonomy resides in the free cash flows generated by the firm: as the availability of free or uncommitted funds increase, managers will invest in unprofitable projects (Jensen and Meckling, 1976). As table 4.1 shows, three broad categories of banks

public and private) each face a slightly different version of the owneragency conflict. However, we argue that agency costs are likely to be lower for both alternative banks in comparison to joint-stock banks. Indeed, for Hansmann (1996), the

managers in joint stock firms may help explain the rapid growth of mutual forms of banking organizations in the 19th century US. Yet authors such as Rasmussen for mutual banks (Rasmussen, 1988), Mayers and Smith for mutual insurance firms (MaySmith, 1994), LaPorta et al., in their work on government banks (La Porta et al., 2002) argue

The mainstream argument that favours joint stock ownership and shareholder governance runs as follows (Ayadi et al, 2010): (i) stakeholder-based banks have more autonomous managers than shareholder-based banks, so they incur higher agency costs; (ii)

based banks cannot rely on market mechanisms to reduce agency costs; and (iii) based banks cannot reduce agency costs by resorting to tools used by private,

stock companies, such as stock options and other schemes linking pay to performance. The question of manager autonomy at alternative banks is complex. According to modern agency theory, diffuse ownership increases managerial autonomy and weakens controls on


tion (1972; 1973). Given the need to monitor team member behavior, but the difficulty both in assessing individual behavior (given information asymmetries and cognitive limitations) and choosing the right

arly theorists focused on the bearer of holder (Fama and Jensen, 1983a and based firm governance, leading some to

all organizations towards this particular organizational

based governance are seen as better able ere ownership and control are

across governance and ownership structures. Building on Cuevas and Fischer (2007), Table 5 in the appendix summarizes the likelihood

k ownership (cooperative, public and private). We also show that monitoring mechanisms differ across bank categories – even between the two broad bank categories we brought together under the larger umbrella of

ic banks. However, we argue here that in both categories overall agency costs are lower than those sustained in for profit, shareholder-based

om ownership (Berle and Means, 1932). Recent theories of the firm emphasize the ability of managers to engage in rent-

preference behavior (Fama and Jensen, 1980b; Hart and Moore, 1990). ng enables managers to pursue their own

interests; this increases agency costs. Indeed, monitoring and controlling managers and designing incentives to align the interests of shareholders and managers can be very costly.

my resides in the free cash flows generated by the firm: as the availability of free or uncommitted funds increase, managers will invest in unprofitable projects (Jensen and Meckling, 1976). As table 4.1 shows, three broad categories of banks

public and private) each face a slightly different version of the owner-manager agency conflict. However, we argue that agency costs are likely to be lower for both

stock banks. Indeed, for Hansmann (1996), the managers in joint stock firms may help explain the rapid growth of mutual

Yet authors such as Rasmussen for mutual banks (Rasmussen, 1988), Mayers and Smith for mutual insurance firms (Mayers & Smith, 1994), LaPorta et al., in their work on government banks (La Porta et al., 2002) argue

The mainstream argument that favours joint stock ownership and shareholder based banks have more

based banks, so they incur higher agency costs; (ii) based banks cannot rely on market mechanisms to reduce agency costs; and (iii)

osts by resorting to tools used by private, stock companies, such as stock options and other schemes linking pay to performance.

The question of manager autonomy at alternative banks is complex. According to modern increases managerial autonomy and weakens controls on

self-interested managers.11 Mutual banks and cooperative banks do indeed have more diffuse ownership because one member one vote principles impede the accumulation of shares as in joint-stock banks: “the [mutual] manager is freed not by the absence of concentration, but by the absence of the threat of concentration” (Rasmussen, 1988: 397). However, recent research on stakeholder governance of local savings banks demonstrates that boards tend to exercise much greater control over executives and managers in comparison to joint stock banks (Hackethal et al, 2005).

From this perspective, savings banks and special purpose banks have a smaller number of stakeholders with higher stakes in the bank governments and representatives from political and social forces. However, this counters a widely accepted axiom of the property rights literature (which has inspired much of the works on agency conflicts): That state ownership is creating incentives for the monitoring of agents. For Shleifer, source of incentives to innovate and become efficient” (1998: 135) while state ownership leads to “grotesque failure” given the patronage and personal income (Shleifer, 1998). Such distortions of principalrelationships arise from presumed weak and perverse incentives in public ownership (Grossman and Hart, 1986; Fama and Jensen, 1983) which concerns public owners and regulators. For Kane, “short-horizoned authorities can allow banks to snatch wealth surreptitiously from taxpayers and simultaneously require loan officers to pass some or all of the wealth that is snatched to a politically designated set of favoured borrowers.” (Kane, 2000: 161). This is the core of neo1998; Shleifer and Vishny, 1997) and the ownership rights literature (critically appraisWeinstein, 2007; 2012). Cornett et al. (2010) claim that statethan privately owned banks citing Shleifer and Vishny (1997) and Kane (2000) to assert that perverse incentives reign over state bureaucrats running financial inMicco et al. (2008) also claim that politics influence statepolicies. Regulators, add Barth et al. (2006), are no “angels”. “devils” either, and that the negative connotatneo-institutional literature, are not explained.stock ownership are presumed superior, because reported correlations are spurious and because broad aggregate compathat shape corporate governance of banks, alternative and private.

While cooperative banks and mutual savings banks do not have shareholders, they have members as well as stakeholders. Becausmember, one vote, regardless of equity stakes, coop ownership is normally very dispersed, which increases managerial autonomy. Cuevas and Fischer (2006) argue that “expense preferences” (the propensity of managcontribution to the firm) constitute the main source of failure for cooperative bank managers; and the dilution of membership, they say, aggravates this problem. Cooperative bank managers also face multiple stakeholder constituencies (Cuevas and Fischer, 2006): members,

11 By contrast, diffused ownership was seen by Bstakeholders involved in the firm’s organization and allows firms to pursue general interest goals as well. Thanks to an anonymous referee for pointing that out.12 These views err because markets and joinreported correlations are spurious and because broad aggregate comparisons of national experiences tend to conceal causal relations that shape corporate governance of banks, alternative and private.


24

Mutual banks and cooperative banks do indeed have more diffuse ownership because one member one vote principles impede the accumulation of shares as in

[mutual] manager is freed not by the absence of concentration, but by the absence of the threat of concentration” (Rasmussen, 1988: 397). However, recent research on stakeholder governance of local savings banks demonstrates that boards tend to exercise

uch greater control over executives and managers in comparison to joint stock banks

From this perspective, savings banks and special purpose banks have a smaller number of stakeholders with higher stakes in the bank – typically local, regional or national governments and representatives from political and social forces. However, this counters a widely accepted axiom of the property rights literature (which has inspired much of the works on agency conflicts): That state ownership is much less apt than private ownership at creating incentives for the monitoring of agents. For Shleifer, “private ownership is the crucial source of incentives to innovate and become efficient” (1998: 135) while state ownership

given the (supposed) utility function of politicians to maximize patronage and personal income (Shleifer, 1998). Such distortions of principalrelationships arise from presumed weak and perverse incentives in public ownership

; Fama and Jensen, 1983) which concerns public owners and horizoned authorities can allow banks to snatch wealth

surreptitiously from taxpayers and simultaneously require loan officers to pass some or all of snatched to a politically designated set of favoured borrowers.” (Kane,

This is the core of neo-institutional theories of corporate governance (Schleifer, 1998; Shleifer and Vishny, 1997) and the ownership rights literature (critically appraisWeinstein, 2007; 2012). Cornett et al. (2010) claim that state-owned banks perform worse than privately owned banks citing Shleifer and Vishny (1997) and Kane (2000) to assert that perverse incentives reign over state bureaucrats running financial institutions. Dinç (2005) & Micco et al. (2008) also claim that politics influence state-owned banks and bias lending policies. Regulators, add Barth et al. (2006), are no “angels”. One may add that they are no “devils” either, and that the negative connotations attached to state actors, pervasive in the

institutional literature, are not explained.12 These views err because markets and joint stock ownership are presumed superior, because reported correlations are spurious and because broad aggregate comparisons of national experiences tend to conceal causal relations that shape corporate governance of banks, alternative and private.

While cooperative banks and mutual savings banks do not have shareholders, they as well as stakeholders. Because coop membership relies on the principle one

member, one vote, regardless of equity stakes, coop ownership is normally very dispersed, which increases managerial autonomy. Cuevas and Fischer (2006) argue that “expense preferences” (the propensity of managers to invest in costly projects regardless of their contribution to the firm) constitute the main source of failure for cooperative bank managers; and the dilution of membership, they say, aggravates this problem. Cooperative bank

ple stakeholder constituencies (Cuevas and Fischer, 2006): members,

By contrast, diffused ownership was seen by Berle as a good thing since it broadens the range of stakeholders involved in the firm’s organization and allows firms to pursue general interest goals as well. Thanks to an anonymous referee for pointing that out.

These views err because markets and joint stock ownership are presumed superior, because reported correlations are spurious and because broad aggregate comparisons of national experiences tend to conceal causal relations that shape corporate governance of banks, alternative and private.


Mutual banks and cooperative banks do indeed have more diffuse ownership because one member one vote principles impede the accumulation of shares as in

[mutual] manager is freed not by the absence of concentration, but by the absence of the threat of concentration” (Rasmussen, 1988: 397). However, recent research on stakeholder governance of local savings banks demonstrates that boards tend to exercise

uch greater control over executives and managers in comparison to joint stock banks

From this perspective, savings banks and special purpose banks have a smaller number al, regional or national

governments and representatives from political and social forces. However, this counters a widely accepted axiom of the property rights literature (which has inspired much of the

much less apt than private ownership at private ownership is the crucial

source of incentives to innovate and become efficient” (1998: 135) while state ownership (supposed) utility function of politicians to maximize

patronage and personal income (Shleifer, 1998). Such distortions of principal-agent relationships arise from presumed weak and perverse incentives in public ownership

; Fama and Jensen, 1983) which concerns public owners and horizoned authorities can allow banks to snatch wealth

surreptitiously from taxpayers and simultaneously require loan officers to pass some or all of snatched to a politically designated set of favoured borrowers.” (Kane,

institutional theories of corporate governance (Schleifer, 1998; Shleifer and Vishny, 1997) and the ownership rights literature (critically appraised in

owned banks perform worse than privately owned banks citing Shleifer and Vishny (1997) and Kane (2000) to assert that

stitutions. Dinç (2005) & owned banks and bias lending

One may add that they are no ions attached to state actors, pervasive in the

These views err because markets and joint stock ownership are presumed superior, because reported correlations are spurious and

risons of national experiences tend to conceal causal relations

While cooperative banks and mutual savings banks do not have shareholders, they e coop membership relies on the principle one

member, one vote, regardless of equity stakes, coop ownership is normally very dispersed, which increases managerial autonomy. Cuevas and Fischer (2006) argue that “expense

ers to invest in costly projects regardless of their contribution to the firm) constitute the main source of failure for cooperative bank managers; and the dilution of membership, they say, aggravates this problem. Cooperative bank

ple stakeholder constituencies (Cuevas and Fischer, 2006): members,

erle as a good thing since it broadens the range of stakeholders involved in the firm’s organization and allows firms to pursue general interest goals as

t stock ownership are presumed superior, because reported correlations are spurious and because broad aggregate comparisons of national experiences tend to conceal causal relations that shape corporate governance of banks, alternative and private.

employees, net borrowers, net savers, public authorities and political and social forces. However, Fama and Jensen (1983) argue that boards with outside directors may control management - even in nonprofit firms.managers and owners (or other stakeholders) in cooperative banks and mutual savings banks lies in the weak incentives presumably inherent to nonmentioned above in the case of public banks). Cooperative members are not exactly similar to a private bank’s shareholders: their degree of control is unrelated to their equity stakes, and they cannot sell their equity stakes in the market. This relates tobank equity as well. Fonteyne speaks of an intergenerational endowment that does not belong to anyone. In this view, managers of cooperative banks should be considered as custodians of the endowment thus reducing members incentivmanagement, raising a series of governance problems (Fonteyne, 2007). However, in such organizations specific governance structures may perform control in a collective fashion and thus perfectly substitute bottomcurrently assumed in the agency theory literature.

In sum, both empirical evidence and theory suggest that alternative banks may manage owner-manager agency conflicts as well or better than jointbank studies (that shareholder-private ownership offers the best incentive for controlling agents) does not hold. Alternative banks have developed different mechanisms through monitoring, control and incentives.

Joint-stock banks can rely on two key devices to lower agency costs; market discipline and contracts inside the bank that provide incentives to align the interests of manthose of shareholders. Market discipline turns on the right of shareholders to sell their shares and/or organize a corporate takeover to change management.oriented banks, value added is appropriated by external sharehincreases in dividends and share buybacks as a way to decrease the free cash flow problem (Jensen, 1986). This is at the core of the shareholder value maximization paradigm, which has remained dominant in corporate finance theory and Kraakman, 2000).

While alternative banks cannot rely on these market mechanisms to discipline managers from outside the banking firm, it does not follow that alternative banks necessarity have a lower capacity to discipline managers (Fonteyne, 2007). First, Cen et al. (2012) show how takeover threats may actually damage the standing of bank managers with stakeholders. Second, alternative banks have developed their own external monitoring and controlling devices. Third, if government owned banks are politically controlled (Shleifer and Vishny,

13 Market discipline remained at the core of bank regulation in the 1990s. For instance, in the Principles for Effective Banking Supervision (1997): “Supervisors should encourage and pursue market disciplgovernance and enhancing market transparency and surveillance” (p.8). In a similar vein: “believe that we ought--where we canmarket discipline. By aligning market incentives with regulatory incentives, policies designed to harness market forces could complement bank supervision by encouraging banks to refrain from excessive risktaking”. “Market Discipline as a Complement to Bank Supervision and RegulGovernor Laurence H. Meyer Before the Conference on Reforming Bank Capital Standards, Council on Foreign Relations, New York June 14, 1999, www.federalreserve.gov/boardDocs/Speeches/1999/19990614.htm.


25

employees, net borrowers, net savers, public authorities and political and social forces. However, Fama and Jensen (1983) argue that boards with outside directors may control

even in nonprofit firms. A third and final source of potential conflicts between managers and owners (or other stakeholders) in cooperative banks and mutual savings banks lies in the weak incentives presumably inherent to non-private ownership forms (as mentioned above in the case of public banks). Cooperative members are not exactly similar to a private bank’s shareholders: their degree of control is unrelated to their equity stakes, and they cannot sell their equity stakes in the market. This relates to the nature of cooperative

Fonteyne speaks of an intergenerational endowment that does not belong to anyone. In this view, managers of cooperative banks should be considered as custodians of the endowment thus reducing members incentives to exert effective oversight over management, raising a series of governance problems (Fonteyne, 2007). However, in such organizations specific governance structures may perform control in a collective fashion and thus perfectly substitute bottom-up control exercised on the basis of individual incentives, as currently assumed in the agency theory literature.

In sum, both empirical evidence and theory suggest that alternative banks may manage manager agency conflicts as well or better than joint-stock banks. The recent bias in

-oriented banks face lower owner-manager problems because private ownership offers the best incentive for controlling agents) does not hold. Alternative banks have developed different mechanisms to reduce owner-manager agency conflicts through monitoring, control and incentives.

stock banks can rely on two key devices to lower agency costs; market discipline and contracts inside the bank that provide incentives to align the interests of man

Market discipline turns on the right of shareholders to sell their shares and/or organize a corporate takeover to change management.13 Moreover, in shareholderoriented banks, value added is appropriated by external shareholders who can demand increases in dividends and share buybacks as a way to decrease the free cash flow problem (Jensen, 1986). This is at the core of the shareholder value maximization paradigm, which has remained dominant in corporate finance theory and practice since the 1980s (Hansmann and

While alternative banks cannot rely on these market mechanisms to discipline managers from outside the banking firm, it does not follow that alternative banks necessarity

cipline managers (Fonteyne, 2007). First, Cen et al. (2012) show how takeover threats may actually damage the standing of bank managers with stakeholders.

alternative banks have developed their own external monitoring and controlling d, if government owned banks are politically controlled (Shleifer and Vishny,

discipline remained at the core of bank regulation in the 1990s. For instance, in the Principles for Effective Banking Supervision published by the Basel Committee on Banking Supervision (1997): “Supervisors should encourage and pursue market discipline by encouraging good corporate governance and enhancing market transparency and surveillance” (p.8). In a similar vein: “

where we can--to skip the middlemen and go right to our first line of defense: ligning market incentives with regulatory incentives, policies designed to harness

market forces could complement bank supervision by encouraging banks to refrain from excessive risk“Market Discipline as a Complement to Bank Supervision and Regulation”, Remarks by

Governor Laurence H. Meyer Before the Conference on Reforming Bank Capital Standards, Council on Foreign Relations, New York June 14, 1999, www.federalreserve.gov/boardDocs/Speeches/1999/19990614.htm.


employees, net borrowers, net savers, public authorities and political and social forces. However, Fama and Jensen (1983) argue that boards with outside directors may control

A third and final source of potential conflicts between managers and owners (or other stakeholders) in cooperative banks and mutual savings banks

private ownership forms (as mentioned above in the case of public banks). Cooperative members are not exactly similar to a private bank’s shareholders: their degree of control is unrelated to their equity stakes, and

the nature of cooperative Fonteyne speaks of an intergenerational endowment that does not belong

to anyone. In this view, managers of cooperative banks should be considered as custodians of es to exert effective oversight over

management, raising a series of governance problems (Fonteyne, 2007). However, in such organizations specific governance structures may perform control in a collective fashion and

trol exercised on the basis of individual incentives, as

In sum, both empirical evidence and theory suggest that alternative banks may manage tock banks. The recent bias in

manager problems because private ownership offers the best incentive for controlling agents) does not hold. Alternative

manager agency conflicts

stock banks can rely on two key devices to lower agency costs; market discipline and contracts inside the bank that provide incentives to align the interests of managers with

Market discipline turns on the right of shareholders to sell their shares Moreover, in shareholder-

olders who can demand increases in dividends and share buybacks as a way to decrease the free cash flow problem (Jensen, 1986). This is at the core of the shareholder value maximization paradigm, which has

practice since the 1980s (Hansmann and

While alternative banks cannot rely on these market mechanisms to discipline managers from outside the banking firm, it does not follow that alternative banks necessarity

cipline managers (Fonteyne, 2007). First, Cen et al. (2012) show how takeover threats may actually damage the standing of bank managers with stakeholders.

alternative banks have developed their own external monitoring and controlling d, if government owned banks are politically controlled (Shleifer and Vishny,

discipline remained at the core of bank regulation in the 1990s. For instance, in the Core published by the Basel Committee on Banking Supervision

ine by encouraging good corporate governance and enhancing market transparency and surveillance” (p.8). In a similar vein: “I also

to skip the middlemen and go right to our first line of defense: ligning market incentives with regulatory incentives, policies designed to harness

market forces could complement bank supervision by encouraging banks to refrain from excessive risk-ation”, Remarks by

Governor Laurence H. Meyer Before the Conference on Reforming Bank Capital Standards, Council on

1989; Dinç, 2005), this implies that governments and public stakeholders exert control over bank managers in comparison to shareholders of joint stock banks. another problem raised by Bhattacharya & Thakor (1993) is the lack of a secondary market for residual claims. However, Ayadi et al. (2010) build on the work of Fama and Jensen (1983) to argue that the equity held by cooperative members (redeemable on demake exit a powerful device to discipline managers, especially given that cooperative usually cannot sell equity on capital market to counter this threat of exit from members potentially withdrawing equity. Paradoxically, the very absencemore powerful as a disciplinary device. Cooperative banks and savings banks can also rely on another powerful external device for disciplining managers: cooperative banks and savings banks developed, over time, shared secondfor payments and transfers, wholesale banking and insurance products and services, and a variety of capital market operations. These second tier banks provide backset up specialized subsidiaries offering complementary services to the ones available in the local banks; in addition, they supply jointensure the overall stability of the network.monitoring and control functions fulfilled by secondGerman cooperative banks first developed regional institutions in the 19specific purpose of performing auditing and monitinstitutions in cooperative networks also exert pressure to avert abuse of free cash flows, either through redistribution to members or through the constitution of crossNetwork supervision also limits(Fonteyne, 2007). Networks also use peer pressure to control and discipline managers of cooperative banks (Fonteyne, 2007). Finally, one may add that cooperative networks constitute joint-supply alliance that address the uncertainties in the procurement of inputs, another rarely considered potential Cuevas and Fischer, 2006).

In sum, alternative banks thereby rely on external control and monitorindiscipline managers at least as effectively as the market mechanisms central to shareholder governance of joint-stock banks.

What about internal devices? In jointshareholders and managers can be offset by contractual devices. The literature on corporate finance and agency theory argue that contractual reowner-manager conflicts – making managers behave as shareholders (Jensen and Zimmerman, 1985). This may beschemes that give executives a vested interest in the performance of a firms stock instance, through stock options. This view has received widespread criticism partly on the basis of lack of any evidence linking stockbelow). Fonteyne (2007) and Cuevas and Fischer (2006) note that these devices are not available to cooperative (or public) banks. mutual managers compensation and his market wage” (Rasmussen, 1988: 398). widespread use of perks in the mutual industry is also a key (negative) point for Fama and Jensen (1983b) and Deshmukh et al. (1982). From this perspective, since perks are cappeand unrelated to individual managerial performance, mutual managers have weak incentives

14 European community regulations reqcross-guarantee schemes as unfair competition by 2005.


26

1989; Dinç, 2005), this implies that governments and public stakeholders exert control over bank managers in comparison to shareholders of joint stock banks. another problem raised by Bhattacharya & Thakor (1993) is the lack of a secondary market for residual claims. However, Ayadi et al. (2010) build on the work of Fama and Jensen (1983) to argue that the equity held by cooperative members (redeemable on demand) does indeed make exit a powerful device to discipline managers, especially given that cooperative usually cannot sell equity on capital market to counter this threat of exit from members potentially withdrawing equity. Paradoxically, the very absence of market exit makes cooperative exit more powerful as a disciplinary device.

Cooperative banks and savings banks can also rely on another powerful external device for disciplining managers: networks. As mentioned above, most local and regional

rative banks and savings banks developed, over time, shared secondfor payments and transfers, wholesale banking and insurance products and services, and a variety of capital market operations. These second tier banks provide backset up specialized subsidiaries offering complementary services to the ones available in the local banks; in addition, they supply joint-liability and cross-guarantee schemes useful to ensure the overall stability of the network.14 Most important here, however, are the monitoring and control functions fulfilled by second-tier network organizations. Indeed, German cooperative banks first developed regional institutions in the 19th

specific purpose of performing auditing and monitoring functions (Guinnane, 1997). The apex institutions in cooperative networks also exert pressure to avert abuse of free cash flows, either through redistribution to members or through the constitution of crossNetwork supervision also limits the ability of managers to appropriate the endowment (Fonteyne, 2007). Networks also use peer pressure to control and discipline managers of cooperative banks (Fonteyne, 2007). Finally, one may add that cooperative networks

e that address the uncertainties in the procurement of inputs, another rarely considered potential locus of agency conflicts (Desrochers and Fischer, 2005;

lternative banks thereby rely on external control and monitorindiscipline managers at least as effectively as the market mechanisms central to shareholder

stock banks. What about internal devices? In joint-stock banks, potential agency conflicts between

n be offset by contractual devices. The literature on corporate finance and agency theory argue that contractual re-alignments of interest may reduce

making managers behave as shareholders (Jensen and Zimmerman, 1985). This may be achieved through pay for performance compensation schemes that give executives a vested interest in the performance of a firms stock instance, through stock options. This view has received widespread criticism partly on the

ence linking stock-options to changes in managerial behavior (see below). Fonteyne (2007) and Cuevas and Fischer (2006) note that these devices are not available to cooperative (or public) banks. Rasmussen calls “perks” the “difference between a

agers compensation and his market wage” (Rasmussen, 1988: 398). widespread use of perks in the mutual industry is also a key (negative) point for Fama and Jensen (1983b) and Deshmukh et al. (1982). From this perspective, since perks are cappeand unrelated to individual managerial performance, mutual managers have weak incentives

European community regulations required local and regional German Sparkasse savings to end guarantee schemes as unfair competition by 2005.


1989; Dinç, 2005), this implies that governments and public stakeholders exert more, not less control over bank managers in comparison to shareholders of joint stock banks. Fourth, another problem raised by Bhattacharya & Thakor (1993) is the lack of a secondary market for residual claims. However, Ayadi et al. (2010) build on the work of Fama and Jensen (1983)

mand) does indeed make exit a powerful device to discipline managers, especially given that cooperative usually cannot sell equity on capital market to counter this threat of exit from members potentially

of market exit makes cooperative exit

Cooperative banks and savings banks can also rely on another powerful external As mentioned above, most local and regional

rative banks and savings banks developed, over time, shared second-tier organizations for payments and transfers, wholesale banking and insurance products and services, and a variety of capital market operations. These second tier banks provide back-office services and set up specialized subsidiaries offering complementary services to the ones available in the

guarantee schemes useful to ant here, however, are the

tier network organizations. Indeed, th century for the

oring functions (Guinnane, 1997). The apex institutions in cooperative networks also exert pressure to avert abuse of free cash flows, either through redistribution to members or through the constitution of cross-guarantees.

the ability of managers to appropriate the endowment (Fonteyne, 2007). Networks also use peer pressure to control and discipline managers of cooperative banks (Fonteyne, 2007). Finally, one may add that cooperative networks

e that address the uncertainties in the procurement of inputs, of agency conflicts (Desrochers and Fischer, 2005;

lternative banks thereby rely on external control and monitoring devices that discipline managers at least as effectively as the market mechanisms central to shareholder

stock banks, potential agency conflicts between n be offset by contractual devices. The literature on corporate

alignments of interest may reduce making managers behave as shareholders (Jensen and

achieved through pay for performance compensation schemes that give executives a vested interest in the performance of a firms stock – for instance, through stock options. This view has received widespread criticism partly on the

options to changes in managerial behavior (see below). Fonteyne (2007) and Cuevas and Fischer (2006) note that these devices are not

Rasmussen calls “perks” the “difference between a agers compensation and his market wage” (Rasmussen, 1988: 398). The assumed

widespread use of perks in the mutual industry is also a key (negative) point for Fama and Jensen (1983b) and Deshmukh et al. (1982). From this perspective, since perks are capped and unrelated to individual managerial performance, mutual managers have weak incentives

uired local and regional German Sparkasse savings to end

to increase risk and profits.15 This argument seems less convincing in the postgiven widespread agreement that executive pay schemes contributed to grosThat alternative banks tend to use performance pay schemes to decrease agency conflicts less than private banks may thereby be a point in their favour.

The literature on pay and performance schemes and executive stock option plans as mechanisms to reduce agency-conflicts (Bebchuk and Fried, 2006) remained mixed before crisis. Indeed skepticism prevailed as to whether stock options would actually work as incentives to maximize shareholder value (Bebchuk & Fried, 2003). The 2007 crisis demonstrated that top bank managers with multibanks very survival at risk by pursuing risky highexcessive executive pay at those large jointaftermath of the crisis. Research from before the crisis also concluded that that, in banks, executive stock option plans may be counterproductive by increasing the incentives of managers to invest in risky assets (Polo, 2007; John andavailability of these contractual devices impairs alternative bank capacity to reduce agency conflicts between owners and managers does not hold. In addition, because payment schemes are often very costly, alternative Research is required to better understand the commitment of managers and employees in alternative banks. The broader social and public policy mandates of alternative banks may provide important incentives for msuggests that the loyalty of employees and depositors is an important source of competitive advantage for cooperative banks. as Hansmann argues, “at best of secondary importance when determining which organizational forms are viable” (Hansmann, 1996: 4).

5.3 Other agency conflicts

Agency conflicts between shareholders and debt holders (or bank depositors) is another problem typical of banks as firms. Asset substitution effect theory suggests that equity holders have greater incentives to take risks for gains than debt holders or depositors who bear most of the consequences of risk related losses (Leland, 1998). Alternative banks are clearly less prone to the asset substitution problem, having no shareholders in the case of public banks, and having holders of non-transferable equity stakes in the case of cooperative banks (Ayadi et al., 2010; Drake and Llewellyn, 2001). While this point is acknowleddiminishes its impact on his overall argument (that mutual banks are less efficient than jointstock banks) by bringing up the issue of the diversity of views among mutual bank depositors, such that only “independent” managers picked binvestment policy” (Rasmussen, 1988). This is in arguments (that managers in mutual banks are more riskstock banks) and self-defeating becausebondholders and depositors: shareholders, who obviously have their own interest and whose difference from bondholders (both with different interests than bank depositors) was the source of this very agency confliabout the relationship between managers and depositors,

15 Interestingly, risk and profits present no problems in Rasmussen’s work.


27

This argument seems less convincing in the postgiven widespread agreement that executive pay schemes contributed to grosThat alternative banks tend to use performance pay schemes to decrease agency conflicts less than private banks may thereby be a point in their favour.

The literature on pay and performance schemes and executive stock option plans as conflicts (Bebchuk and Fried, 2006) remained mixed before

crisis. Indeed skepticism prevailed as to whether stock options would actually work as incentives to maximize shareholder value (Bebchuk & Fried, 2003). The 2007 crisis

onstrated that top bank managers with multi-million stock option plans often put their banks very survival at risk by pursuing risky high-yield strategies (Sorkin, 2011). In fact, excessive executive pay at those large joint-stock banks has become a key poaftermath of the crisis. Research from before the crisis also concluded that that, in banks, executive stock option plans may be counterproductive by increasing the incentives of managers to invest in risky assets (Polo, 2007; John and Qian, 2003). It follows that the nonavailability of these contractual devices impairs alternative bank capacity to reduce agency conflicts between owners and managers does not hold. In addition, because payment schemes are often very costly, alternative banks may indeed be better off without them. Research is required to better understand the commitment of managers and employees in alternative banks. The broader social and public policy mandates of alternative banks may provide important incentives for managers to perform well. Indeed, Fonteyene (2007)

employees and depositors is an important source of competitive advantage for cooperative banks. Finally, the agency costs of delegated management might be,

“at best of secondary importance when determining which organizational forms are viable” (Hansmann, 1996: 4).

Agency conflicts between shareholders and debt holders (or bank depositors) is another rms. Asset substitution effect theory suggests that equity holders

have greater incentives to take risks for gains than debt holders or depositors who bear most of the consequences of risk related losses (Leland, 1998). Alternative banks are clearly less

rone to the asset substitution problem, having no shareholders in the case of public banks, transferable equity stakes in the case of cooperative banks (Ayadi

et al., 2010; Drake and Llewellyn, 2001). While this point is acknowledged by Rasmussen, he diminishes its impact on his overall argument (that mutual banks are less efficient than joint

by bringing up the issue of the diversity of views among mutual bank depositors, such that only “independent” managers picked by shareholders could guarantee a “cautious investment policy” (Rasmussen, 1988). This is in stark contradictions with previous arguments (that managers in mutual banks are more risk-adverse than their peers in joint

defeating because he brings in another group, different from bondholders and depositors: shareholders, who obviously have their own interest and whose difference from bondholders (both with different interests than bank depositors) was the source of this very agency conflict in the first place. Contrary to these mainstream stories about the relationship between managers and depositors, “the managers of investor owned

Interestingly, risk and profits present no problems in Rasmussen’s work.


This argument seems less convincing in the post-crisis world given widespread agreement that executive pay schemes contributed to gross errors of banks. That alternative banks tend to use performance pay schemes to decrease agency conflicts less

The literature on pay and performance schemes and executive stock option plans as conflicts (Bebchuk and Fried, 2006) remained mixed before

crisis. Indeed skepticism prevailed as to whether stock options would actually work as incentives to maximize shareholder value (Bebchuk & Fried, 2003). The 2007 crisis

million stock option plans often put their yield strategies (Sorkin, 2011). In fact,

stock banks has become a key political issue in the aftermath of the crisis. Research from before the crisis also concluded that that, in banks, executive stock option plans may be counterproductive by increasing the incentives of

Qian, 2003). It follows that the non-availability of these contractual devices impairs alternative bank capacity to reduce agency conflicts between owners and managers does not hold. In addition, because payment schemes

banks may indeed be better off without them. Research is required to better understand the commitment of managers and employees in alternative banks. The broader social and public policy mandates of alternative banks may

anagers to perform well. Indeed, Fonteyene (2007) employees and depositors is an important source of competitive

Finally, the agency costs of delegated management might be, “at best of secondary importance when determining which

Agency conflicts between shareholders and debt holders (or bank depositors) is another rms. Asset substitution effect theory suggests that equity holders

have greater incentives to take risks for gains than debt holders or depositors who bear most of the consequences of risk related losses (Leland, 1998). Alternative banks are clearly less

rone to the asset substitution problem, having no shareholders in the case of public banks, transferable equity stakes in the case of cooperative banks (Ayadi

ged by Rasmussen, he diminishes its impact on his overall argument (that mutual banks are less efficient than joint-

by bringing up the issue of the diversity of views among mutual bank depositors, y shareholders could guarantee a “cautious stark contradictions with previous

adverse than their peers in joint-he brings in another group, different from

bondholders and depositors: shareholders, who obviously have their own interest and whose difference from bondholders (both with different interests than bank depositors) was the

ct in the first place. Contrary to these mainstream stories “the managers of investor owned-

firms are much more willing to speculate with their depositors' funds than are the managers of customer-owned and non-profit firm” (Hansmann, 1996: 263).

Further agency conflicts unique to banks arise between the depositors and borrowers. Indeed, theories of delegated monitoring explain how banks form as coalitions of depositors wishing to reduce the cost of motheory, borrowers and depositors have fundamentally different interests. Depositors tend to be risk-adverse and have a high liquidity preference, while borrowers have a low liquidity preference and are risk-prone.17

costs with respect to direct finance. We argue that alternative banks incur lower costs from agency conflicts between depositors and borrowers than joint stock private banks.

First, cooperative banks and mutual savings banks (depositors) and borrowers and align their interests (Valneck, 1999). Cooperative bank members are both owners and its depositors, and the borrowers often have to be members and depositors as well. For Cuevas & Fischer (2006), cooperative banks may face similar agency conflicts between net borrowers (cooperative members whose borrowing exceeds personal deposits) and net lenders (the opposite). Perhaps, but this agency conflict appmuch more benign than conflicts between depositors and borrowers in jointFirst, net borrowers in a cooperative bank have a vested interest in the sustainability of their bank over time – not only because they are also bank owners (indeeddemonstrated that some net borrowers would gain more from their refusal to pay back their loans than lose from the bank’s failure, which looks like the problem afflicting common goods), but also because most cooperative bank borrowing takes time – it is relation-based rather than transactionacross cooperative bank members and involving stakeholders and the local community, reduces this conflict (Ghatak, 2000).

In government savings banks and special purpose banks, investors also retain different interests than borrowers. However, this agency conflict is attenuated because government officials, as investors, have a different clientele and a different degree of riskprivate investors. For example, local and regional government savings banks and regional and national development or special purpose banks usually lead in credit and finance to the public sector and direct funds to social housing programs. Managers of plower incentives and more restricted opportunities to behave opportunistically, given their tighter networks to bank stakeholders and the prerogatives of control exercised by corporate boards. Public banks also have explicit missunbanked (lower income households) or small and medium enterprises that cannot access capital markets and are often shunned by private banks. Low income clients and small and medium enterprises may present greatebut agency conflicts and costs are lower.

The corporate cultures of alternative banks also reduce agency conflicts between owners and managers and provide a different set of incentives than joint stoc

16 As remarked by an anonymous reviewer, this view assumes that (i) dedeposits pre-exist to banking, both assumptions which are actually questionable. We agree, but our point here is precisely to show how the existing works on alternative banks purport to explain their feature/behavior/performance within an inappropriate conceptual framework.17 This asymmetry between shortertheory of banks as liquidity creators, which is discussed below in relation to risk18 The issue of relationship banking is dealt with in the next section.


28

firms are much more willing to speculate with their depositors' funds than are the managers profit firm” (Hansmann, 1996: 263).

Further agency conflicts unique to banks arise between the depositors and borrowers. Indeed, theories of delegated monitoring explain how banks form as coalitions of depositors wishing to reduce the cost of monitoring borrowers (Diamond, 1984).16 According to this theory, borrowers and depositors have fundamentally different interests. Depositors tend to

adverse and have a high liquidity preference, while borrowers have a low liquidity 17 Banks do not eliminate this agency conflict


st, cooperative banks and mutual savings banks bridge the gap between debtors (depositors) and borrowers and align their interests (Valneck, 1999). Cooperative bank

owners and its depositors, and the borrowers often have to be members depositors as well. For Cuevas & Fischer (2006), cooperative banks may face similar

borrowers (cooperative members whose borrowing exceeds lenders (the opposite). Perhaps, but this agency conflict app

more benign than conflicts between depositors and borrowers in jointFirst, net borrowers in a cooperative bank have a vested interest in the sustainability of their

not only because they are also bank owners (indeed, it could be demonstrated that some net borrowers would gain more from their refusal to pay back their loans than lose from the bank’s failure, which looks like the problem afflicting common

but also because most cooperative bank borrowing takes place over a long period of based rather than transaction-based.18 Moreover, peer pressure, both

across cooperative bank members and involving stakeholders and the local community, reduces this conflict (Ghatak, 2000).

savings banks and special purpose banks, investors also retain different interests than borrowers. However, this agency conflict is attenuated because government officials, as investors, have a different clientele and a different degree of riskprivate investors. For example, local and regional government savings banks and regional and national development or special purpose banks usually lead in credit and finance to the public sector and direct funds to social housing programs. Managers of public banks therefore have lower incentives and more restricted opportunities to behave opportunistically, given their tighter networks to bank stakeholders and the prerogatives of control exercised by corporate boards. Public banks also have explicit missions to reach and serve clients such as the unbanked (lower income households) or small and medium enterprises that cannot access capital markets and are often shunned by private banks. Low income clients and small and medium enterprises may present greater risk and, therefore, involve higher monitoring costs; but agency conflicts and costs are lower.

The corporate cultures of alternative banks also reduce agency conflicts between owners and managers and provide a different set of incentives than joint stoc

As remarked by an anonymous reviewer, this view assumes that (i) depositors are investors and (ii) exist to banking, both assumptions which are actually questionable. We agree, but our

point here is precisely to show how the existing works on alternative banks purport to explain their ance within an inappropriate conceptual framework.

This asymmetry between shorter-term liabilities and longer-term assets also lies at the root of the theory of banks as liquidity creators, which is discussed below in relation to risk

e of relationship banking is dealt with in the next section.


firms are much more willing to speculate with their depositors' funds than are the managers

Further agency conflicts unique to banks arise between the depositors and borrowers. Indeed, theories of delegated monitoring explain how banks form as coalitions of depositors

According to this theory, borrowers and depositors have fundamentally different interests. Depositors tend to

adverse and have a high liquidity preference, while borrowers have a low liquidity Banks do not eliminate this agency conflict – they reduce its


bridge the gap between debtors (depositors) and borrowers and align their interests (Valneck, 1999). Cooperative bank

owners and its depositors, and the borrowers often have to be members depositors as well. For Cuevas & Fischer (2006), cooperative banks may face similar

borrowers (cooperative members whose borrowing exceeds lenders (the opposite). Perhaps, but this agency conflict appears

more benign than conflicts between depositors and borrowers in joint-stock banks. First, net borrowers in a cooperative bank have a vested interest in the sustainability of their

, it could be demonstrated that some net borrowers would gain more from their refusal to pay back their loans than lose from the bank’s failure, which looks like the problem afflicting common

place over a long period of peer pressure, both

across cooperative bank members and involving stakeholders and the local community,

savings banks and special purpose banks, investors also retain different interests than borrowers. However, this agency conflict is attenuated because government officials, as investors, have a different clientele and a different degree of risk-aversion than private investors. For example, local and regional government savings banks and regional and national development or special purpose banks usually lead in credit and finance to the public

ublic banks therefore have lower incentives and more restricted opportunities to behave opportunistically, given their tighter networks to bank stakeholders and the prerogatives of control exercised by corporate

ions to reach and serve clients such as the unbanked (lower income households) or small and medium enterprises that cannot access capital markets and are often shunned by private banks. Low income clients and small and

r risk and, therefore, involve higher monitoring costs;

The corporate cultures of alternative banks also reduce agency conflicts between owners and managers and provide a different set of incentives than joint stock banks. The

positors are investors and (ii) exist to banking, both assumptions which are actually questionable. We agree, but our

point here is precisely to show how the existing works on alternative banks purport to explain their

term assets also lies at the root of the theory of banks as liquidity creators, which is discussed below in relation to risk-taking.

social and public policy missions, and payment and career schemes that shun short term profit maximization and excessive risk, produce more altruistic management cultures and behavior at alternative banks. However, as Rasmussen emphasizes, “whsavings bank is not so much altruism as stability and conservatism” and “an altruistic manager devoted to buying the best highadverse scoundrel” (1988: 407).products and services offered by a bank reduce potential agency conflicts between managers, stockholders, and bondholders. Given that savings banks and cooperative banks tend to be smaller local and regional banks, and tend to offthat agency conflicts are thereby reduced in alternative banks as well.

Finally, the costs of agency conflicts between depositors and bank management tend to be substantially lower in alternative banks becausinstitutions by clients and the general public (note, “what makes the mutual form the preferred structure is that it resolves the classic shareholder deposit conflict regarding the appropriate level of risk” (1993: 15). This is especially true in times of crisis. Ibetter banks” (Dietrich and Wanzenried, 2011: 321). The greater trust of depositors and the public in alternative banks is due to their long history, local rooting, stakeholder governance and corporate reputations based on social and public policy missions. In the past, savings bank guarantee of small deposits were critical for development of this tcrisis depositors often shift funds to public savings banks reinforcing both the proweaknesses of private banks and the counterbanks (Schclarek Curutchet, 2014; Mettenheim, 2010)more effectively than joint-stock banks provides alternative banks with substantial competitive advantages.19

A closer look at agency theory also reveals how agency theory fails to account for the more complex interactions among alternative bank stakeholders. behind mainstream theories of the firm, sees governance primarily as reducing or eliminating potential agency conflicts between owners and stakeholders. Critics of theories of t(Biondi et al., 2007; Weinstein, 2012) approach to analyze the performance, stability and survival of banks. Indeed, one problem of firms in the US are the theories that inform corporate governance. Wcontracts, without any institutional or organizational existence outside of legal forms (Weinstein, 2007). By focusing on the specific costs and benefits in their contracts, managers in the US can hardly have an interest in the firms

Indeed, as Berle and Means emphasized over 80 years ago, the “traditional logic of ownership” (that underpins agency theory today) fails to account for the degree, and logic, of shareholder involvement in large corpWeinstein, 2007). Agency theory fails to capture the complexity of modern economic organizations, especially banks. As Biondi argues, “rather than the so

19 It is ironic that, before the 2007-bank governance from empire-building and appropriation risks that were subsequently foundpervasive among private banks. 20 “An integrated hierarchical reward structure ceased to regulate the pay of top executives, who embraced wholeheartedly the ideology of maximizing shareholder value as their boards bestowed on them ever more generous stock-option awards” (Lazonick, 2010: 684).


29

social and public policy missions, and payment and career schemes that shun short term profit maximization and excessive risk, produce more altruistic management cultures and

However, as Rasmussen emphasizes, “what is important in a savings bank is not so much altruism as stability and conservatism” and “an altruistic manager devoted to buying the best high-yield, high-risk securities is worse than a riskadverse scoundrel” (1988: 407). Rasmussen also suggests that less complex mixes of products and services offered by a bank reduce potential agency conflicts between managers, stockholders, and bondholders. Given that savings banks and cooperative banks tend to be smaller local and regional banks, and tend to offer a narrower range of products; this suggests that agency conflicts are thereby reduced in alternative banks as well.

Finally, the costs of agency conflicts between depositors and bank management tend to be substantially lower in alternative banks because of the higher level of trust placed in these institutions by clients and the general public (Größl et al, 2013). As Bhattacharya and Thakor note, “what makes the mutual form the preferred structure is that it resolves the classic

flict regarding the appropriate level of risk” (1993: 15). This is especially true in times of crisis. In hard times, state-owned banks are considered “safe and better banks” (Dietrich and Wanzenried, 2011: 321). The greater trust of depositors and the

lic in alternative banks is due to their long history, local rooting, stakeholder governance and corporate reputations based on social and public policy missions. In the past, savings bank guarantee of small deposits were critical for development of this trust. Indeed, amidst crisis depositors often shift funds to public savings banks reinforcing both the proweaknesses of private banks and the counter-cyclical liability base of government savings

Schclarek Curutchet, 2014; Mettenheim, 2010)to reduce the costs of agency conflicts stock banks provides alternative banks with substantial

A closer look at agency theory also reveals how agency theory fails to account for the interactions among alternative bank stakeholders. Agency theory, as the theory

behind mainstream theories of the firm, sees governance primarily as reducing or eliminating potential agency conflicts between owners and stakeholders. Critics of theories of t(Biondi et al., 2007; Weinstein, 2012) suggest that agency theory may not be the best approach to analyze the performance, stability and survival of banks. Indeed, one problem of firms in the US are the theories that inform corporate governance. When seen as bundle of contracts, without any institutional or organizational existence outside of legal forms (Weinstein, 2007). By focusing on the specific costs and benefits in their contracts, managers in the US can hardly have an interest in the firms long-term well-being (Lazonick, 2010)

Indeed, as Berle and Means emphasized over 80 years ago, the “traditional logic of ownership” (that underpins agency theory today) fails to account for the degree, and logic, of shareholder involvement in large corporations (Berle and Means, 1932; Berle, 1965; Weinstein, 2007). Agency theory fails to capture the complexity of modern economic organizations, especially banks. As Biondi argues, “rather than the so-called ‘ownership

-8 crisis, Fonteyne (2007) highlighted the risks posed by cooperative building and appropriation risks that were subsequently found

“An integrated hierarchical reward structure ceased to regulate the pay of top executives, who embraced wholeheartedly the ideology of maximizing shareholder value as their boards bestowed on

option awards” (Lazonick, 2010: 684).


social and public policy missions, and payment and career schemes that shun short term profit maximization and excessive risk, produce more altruistic management cultures and

at is important in a savings bank is not so much altruism as stability and conservatism” and “an altruistic

risk securities is worse than a risk-hat less complex mixes of

products and services offered by a bank reduce potential agency conflicts between managers, stockholders, and bondholders. Given that savings banks and cooperative banks tend to be

er a narrower range of products; this suggests

Finally, the costs of agency conflicts between depositors and bank management tend to e of the higher level of trust placed in these

As Bhattacharya and Thakor note, “what makes the mutual form the preferred structure is that it resolves the classic

flict regarding the appropriate level of risk” (1993: 15). This is owned banks are considered “safe and

better banks” (Dietrich and Wanzenried, 2011: 321). The greater trust of depositors and the lic in alternative banks is due to their long history, local rooting, stakeholder governance

and corporate reputations based on social and public policy missions. In the past, savings rust. Indeed, amidst

crisis depositors often shift funds to public savings banks reinforcing both the pro-cyclical cyclical liability base of government savings

to reduce the costs of agency conflicts stock banks provides alternative banks with substantial

A closer look at agency theory also reveals how agency theory fails to account for the Agency theory, as the theory

behind mainstream theories of the firm, sees governance primarily as reducing or eliminating potential agency conflicts between owners and stakeholders. Critics of theories of the firm

suggest that agency theory may not be the best approach to analyze the performance, stability and survival of banks. Indeed, one problem of

hen seen as bundle of contracts, without any institutional or organizational existence outside of legal forms (Weinstein, 2007). By focusing on the specific costs and benefits in their contracts, managers

being (Lazonick, 2010)20. Indeed, as Berle and Means emphasized over 80 years ago, the “traditional logic of

ownership” (that underpins agency theory today) fails to account for the degree, and logic, of orations (Berle and Means, 1932; Berle, 1965;

Weinstein, 2007). Agency theory fails to capture the complexity of modern economic called ‘ownership

8 crisis, Fonteyne (2007) highlighted the risks posed by cooperative building and appropriation risks that were subsequently found to be so

“An integrated hierarchical reward structure ceased to regulate the pay of top executives, who embraced wholeheartedly the ideology of maximizing shareholder value as their boards bestowed on

structure’ of the firm, it is the enduis fundamental” (Biondi, 2007: 252).

This reinforces our view that comparing banks cannot be limited to questions of ownership and control. While governance matters, alternative banks differ frin three further critical ways; by their longlower risk, their local rooting and relational retail banking, and their core social and public policy missions. These characteristics of alternatsustain substantial competitive advantages over private banks and cannot be fully understood within the framework of agency theory. We therefore expand our scope of analysis to concepts from contemporary banking theemphasize institutional foundations of competitive advantage.

6. Alternative banks mitigate information asymmetries through relationship banking

For contemporary banking theory, information asymmetries explaiin banking. Knowing more than creditors, borrowers may behave opportunistically and cause moral hazard problems, increase credit risk and impede effective management of portfolios. Lack of information about clients or indeed neighbselection through, for instance, credit rationing by loan officers (Stiglitz & Weiss, 1981). One way to reduce information asymmetries and the inefficiencies they entail is through relationship banking, the subject of past two decades (Boot, 2000). services by a financial intermediary that: (i) invests in obtaining customerinformation, often proprietary in nature, and (ii) evaluates the profitability of these investments through multiple interactions with some customers over time and or across products” (2000: 10). Relationship banking has multiple advantages. It adds value by improving the exchange of information between banks and borrowers and improves contractual relations between banks and borrowers (Boot, 2000). Relationship banking improves the availability of credit (Petersen and Rajan, 1994) and reduces collateral requirements and the cost of financial distress (Hoshi et al., 1990).

Alternative banks are uniquely positioned to reap the competitive advantages of relationship banking. First, cooperative banks and savings banks are much closer to clients (depositors and borrowers) becnetwork. Soft information (as opposed to hard information from standardized screening and monitoring procedures) gathered through proximity with customers is a key source of competitive advantage of alternative banks over private banks (Ayadi et al., 2009 & 2010; Fonteyne, 2007; Cuevas and Fischer, 2006). Carnevali (2005) argues that local organizational networks and lending discretion provide European savings banks with competitive advantages and permit better lending to help usher small and medium enterprises through economic downturns. Fonteyne (2007) argues that large fixed costs and that the many new products and services that do not require branch offices mean they will lose relevance in the near future. Theories of relationship banking suggest the contrary. And the continuity strategy of retail oriented alternative banks to add, rather than reduce bank branches, also suggests that branch office networks are a sustain competitive advantage. in segments of the banking market (such as lending in lowasymmetries discourage joint-stock banks Mettenheim, 2010).


30

structure’ of the firm, it is the enduring existence and financial viability of the whole firm that is fundamental” (Biondi, 2007: 252).

This reinforces our view that comparing banks cannot be limited to questions of ownership and control. While governance matters, alternative banks differ frin three further critical ways; by their long-term horizons based on sustainable returns and lower risk, their local rooting and relational retail banking, and their core social and public policy missions. These characteristics of alternative banks have developed over decades to sustain substantial competitive advantages over private banks and cannot be fully understood within the framework of agency theory. We therefore expand our scope of analysis to concepts from contemporary banking theory and heterodox theories of the firm that emphasize institutional foundations of competitive advantage.


For contemporary banking theory, information asymmetries explain a variety of phenomena in banking. Knowing more than creditors, borrowers may behave opportunistically and cause moral hazard problems, increase credit risk and impede effective management of portfolios. Lack of information about clients or indeed neighborhoods may, in turn, produce adverse selection through, for instance, credit rationing by loan officers (Stiglitz & Weiss, 1981). One way to reduce information asymmetries and the inefficiencies they entail is through relationship banking, the subject of a considerable empirical and theoretical literature in the past two decades (Boot, 2000). Boot defines relationship banking as “the provision of financial services by a financial intermediary that: (i) invests in obtaining customer

ten proprietary in nature, and (ii) evaluates the profitability of these investments through multiple interactions with some customers over time and or across

Relationship banking has multiple advantages. It adds value by he exchange of information between banks and borrowers and improves

contractual relations between banks and borrowers (Boot, 2000). Relationship banking improves the availability of credit (Petersen and Rajan, 1994) and reduces collateral

the cost of financial distress (Hoshi et al., 1990). Alternative banks are uniquely positioned to reap the competitive advantages of

relationship banking. First, cooperative banks and savings banks are much closer to clients (depositors and borrowers) because of their small size, local rooting and extensive branch network. Soft information (as opposed to hard information from standardized screening and monitoring procedures) gathered through proximity with customers is a key source of

of alternative banks over private banks (Ayadi et al., 2009 & 2010; Fonteyne, 2007; Cuevas and Fischer, 2006). Carnevali (2005) argues that local organizational networks and lending discretion provide European savings banks with competitive

permit better lending to help usher small and medium enterprises through economic downturns. Fonteyne (2007) argues that large branch office networks increase fixed costs and that the many new products and services that do not require branch offices

they will lose relevance in the near future. Theories of relationship banking suggest the contrary. And the continuity strategy of retail oriented alternative banks to add, rather than reduce bank branches, also suggests that branch office networks are a key investment to

As a matter of fact, alternative banks continue to operate, well, in segments of the banking market (such as lending in low-income areas) where information

stock banks (McGregor, 2005; McKillop and Wilson, 2011;


ring existence and financial viability of the whole firm that

This reinforces our view that comparing banks cannot be limited to questions of ownership and control. While governance matters, alternative banks differ from private banks

term horizons based on sustainable returns and lower risk, their local rooting and relational retail banking, and their core social and public

ive banks have developed over decades to sustain substantial competitive advantages over private banks and cannot be fully understood within the framework of agency theory. We therefore expand our scope of analysis to

ory and heterodox theories of the firm that


n a variety of phenomena in banking. Knowing more than creditors, borrowers may behave opportunistically and cause moral hazard problems, increase credit risk and impede effective management of portfolios.

orhoods may, in turn, produce adverse selection through, for instance, credit rationing by loan officers (Stiglitz & Weiss, 1981). One way to reduce information asymmetries and the inefficiencies they entail is through

a considerable empirical and theoretical literature in the Boot defines relationship banking as “the provision of financial

services by a financial intermediary that: (i) invests in obtaining customer-specific ten proprietary in nature, and (ii) evaluates the profitability of these

investments through multiple interactions with some customers over time and or across Relationship banking has multiple advantages. It adds value by

he exchange of information between banks and borrowers and improves contractual relations between banks and borrowers (Boot, 2000). Relationship banking improves the availability of credit (Petersen and Rajan, 1994) and reduces collateral

Alternative banks are uniquely positioned to reap the competitive advantages of relationship banking. First, cooperative banks and savings banks are much closer to clients

ause of their small size, local rooting and extensive branch network. Soft information (as opposed to hard information from standardized screening and monitoring procedures) gathered through proximity with customers is a key source of

of alternative banks over private banks (Ayadi et al., 2009 & 2010; Fonteyne, 2007; Cuevas and Fischer, 2006). Carnevali (2005) argues that local organizational networks and lending discretion provide European savings banks with competitive

permit better lending to help usher small and medium enterprises through branch office networks increase

fixed costs and that the many new products and services that do not require branch offices they will lose relevance in the near future. Theories of relationship banking suggest the

contrary. And the continuity strategy of retail oriented alternative banks to add, rather than key investment to

As a matter of fact, alternative banks continue to operate, well, income areas) where information

2005; McKillop and Wilson, 2011;

Being closer to their customers reinforces relationship banking and trust. As Kay (1991) argues, “the special value of mutuality rests on its relationship contract structures.” This provides a comparative advantage in establishing trust (Kay, 2006). Trust is also sustained by how public banks and cooperative banks distribute returns and value added. While value added in joint stock banks is appropriated by external shareholders, alternative banks distribute value added to customers and members through lower-priced loans or a higher interest paid on deposits (Ayadi et al., 2010). This also reinforces the inter-temporal risk smoothing capacity of alternative banks (see next Moreover, the social mission and identities of alternative banks also lead to the distribution of returns through substantial funding of social and cultural projects in local communities levels much higher than the strategic corporate socialBecause members and clients of credit unions and mutual banks tend to belong to employment groups or limited geographical areas, they are more homogeneous and cohesive than private bank clients (Hansmann, 1996).

Credit unions and mutual banks thereby face fewer problems from adverse selection and moral hazard, and are better able to mitigate counterparty risk than private banks (Hart and Moore, 1990). Some argue that such benefits are limited to smallin less complex operations (Akella & Greenbaum, 1988; Rasmussen, 1988; Berlin & Mester, 1998). However, the combination of smaller retail operations (local and regional savings banks and cooperative banks) with shared wholesale banking organizationsalternative banking groups to retain the best of both worlds.

The advantages brought about by small size, local rooting and extensive branch network thereby can be maintained while shared operations realize economies of scale and reduce the cost of providing wholesale products and services, capital market operations and other services such as insurance, factoring and leasing. Fonteyne (2007) argues that cooperative banks have lost traditional competitive advantages of overcoming opportunistic behavior by borrowers (because of the increase in size and the growing distance between cooperative banks and members; and because contracts have become more enforceable by commercial banks). We disagree. Indeed, cooperative and savings banks, very early in thehistory, developed a solution to this supposed tradeeconomies of scale: two-layer structuressolution to several agency problems in banking. They also solve the appartradeoffs between relationship banking and economies of scale. economies of scale and enhance bank funding opportunities (Ayadi et al., 2010; Cuevas and Fischer, 2006). Joining a cooperative banking network may also reduceperformance among cooperatives through joint(Cuevas and Fischer, 2006) discussed below. And twoeconomies of scale while avoiding the pitfalls of vertical integrargue that the expense preferences of managers increase with institutional size networks. Networks also expand the range of products and services offered by local banks, which reinforces relationship banking (tiered networks of alternative banks may increase ”appropriability hazards” rider problem that arises from new agency conflicts within the network (Ayadi et al., 2010, Desrochers and Fischer, 2005). However, given the long history of the wholesale operations shared by local and regional cooperative banks and savings banks, these hazards seem to have

21 Thanks go to an anonymous reviewer for the suggestion.


31

eing closer to their customers reinforces relationship banking and trust. As Kay (1991) argues, “the special value of mutuality rests on its capacity to establish and sustain

tures.” This provides a comparative advantage in establishing trust (Kay, 2006). Trust is also sustained by how public banks and cooperative banks distribute returns and value added. While value added in joint stock banks is appropriated by external

olders, alternative banks distribute value added to customers and members through priced loans or a higher interest paid on deposits (Ayadi et al., 2010). This also

temporal risk smoothing capacity of alternative banks (see next Moreover, the social mission and identities of alternative banks also lead to the distribution of returns through substantial funding of social and cultural projects in local communities levels much higher than the strategic corporate social responsibilities of private banks.Because members and clients of credit unions and mutual banks tend to belong to employment groups or limited geographical areas, they are more homogeneous and cohesive than private bank clients (Hansmann, 1996).

unions and mutual banks thereby face fewer problems from adverse selection and moral hazard, and are better able to mitigate counterparty risk than private banks (Hart and Moore, 1990). Some argue that such benefits are limited to small-scale banks speciin less complex operations (Akella & Greenbaum, 1988; Rasmussen, 1988; Berlin & Mester, 1998). However, the combination of smaller retail operations (local and regional savings banks and cooperative banks) with shared wholesale banking organizationsalternative banking groups to retain the best of both worlds.

The advantages brought about by small size, local rooting and extensive branch network thereby can be maintained while shared operations realize economies of scale and

f providing wholesale products and services, capital market operations and other services such as insurance, factoring and leasing. Fonteyne (2007) argues that cooperative banks have lost traditional competitive advantages of overcoming opportunistic

ior by borrowers (because of the increase in size and the growing distance between cooperative banks and members; and because contracts have become more enforceable by commercial banks). We disagree. Indeed, cooperative and savings banks, very early in thehistory, developed a solution to this supposed trade-off between relationship banking and

layer structures. Such structures have been mentioned above as a solution to several agency problems in banking. They also solve the appartradeoffs between relationship banking and economies of scale. Networks encourage economies of scale and enhance bank funding opportunities (Ayadi et al., 2010; Cuevas and Fischer, 2006). Joining a cooperative banking network may also reduce the volatility of performance among cooperatives through joint-liability and cross-guarantee arrangements (Cuevas and Fischer, 2006) discussed below. And two-tiered networks help banks reap economies of scale while avoiding the pitfalls of vertical integration. Fama and Jensen (1983) argue that the expense preferences of managers increase with institutional size

Networks also expand the range of products and services offered by local banks, relationship banking (Boot, 2000; Degryse and Van Cayseele, 2000). The

tiered networks of alternative banks may increase ”appropriability hazards” rider problem that arises from new agency conflicts within the network (Ayadi et al., 2010,

scher, 2005). However, given the long history of the wholesale operations shared by local and regional cooperative banks and savings banks, these hazards seem to have

Thanks go to an anonymous reviewer for the suggestion.


eing closer to their customers reinforces relationship banking and trust. As Kay capacity to establish and sustain

tures.” This provides a comparative advantage in establishing trust (Kay, 2006). Trust is also sustained by how public banks and cooperative banks distribute returns and value added. While value added in joint stock banks is appropriated by external

olders, alternative banks distribute value added to customers and members through priced loans or a higher interest paid on deposits (Ayadi et al., 2010). This also

temporal risk smoothing capacity of alternative banks (see next section). Moreover, the social mission and identities of alternative banks also lead to the distribution of returns through substantial funding of social and cultural projects in local communities – at

responsibilities of private banks.21 Because members and clients of credit unions and mutual banks tend to belong to employment groups or limited geographical areas, they are more homogeneous and cohesive

unions and mutual banks thereby face fewer problems from adverse selection and moral hazard, and are better able to mitigate counterparty risk than private banks (Hart

scale banks specialized in less complex operations (Akella & Greenbaum, 1988; Rasmussen, 1988; Berlin & Mester, 1998). However, the combination of smaller retail operations (local and regional savings banks and cooperative banks) with shared wholesale banking organizations enables

The advantages brought about by small size, local rooting and extensive branch network thereby can be maintained while shared operations realize economies of scale and

f providing wholesale products and services, capital market operations and other services such as insurance, factoring and leasing. Fonteyne (2007) argues that cooperative banks have lost traditional competitive advantages of overcoming opportunistic

ior by borrowers (because of the increase in size and the growing distance between cooperative banks and members; and because contracts have become more enforceable by commercial banks). We disagree. Indeed, cooperative and savings banks, very early in their

off between relationship banking and . Such structures have been mentioned above as a

solution to several agency problems in banking. They also solve the apparently zero sum Networks encourage

economies of scale and enhance bank funding opportunities (Ayadi et al., 2010; Cuevas and the volatility of

guarantee arrangements tiered networks help banks reap

ation. Fama and Jensen (1983) argue that the expense preferences of managers increase with institutional size - but less so in

Networks also expand the range of products and services offered by local banks, Boot, 2000; Degryse and Van Cayseele, 2000). The two

tiered networks of alternative banks may increase ”appropriability hazards” –basically a free-rider problem that arises from new agency conflicts within the network (Ayadi et al., 2010,

scher, 2005). However, given the long history of the wholesale operations shared by local and regional cooperative banks and savings banks, these hazards seem to have

been mitigated by network integration, peer pressure and corporate cultures as emphasizedabove.

In sum, alternative banks retain unique twolocal and regional retail banking institutions and shared wholesale operations, providing alternative banks significant advantages in terms of economies of scalindeed deepening retail relationship banking.

7. Alternative bank funding, equity, reserves and patrimony

Alternative banks also fund operations, manage equity, and hold reserves and patrimony in ways fundamentally different than alternative banking history, cooperative banks and savings banks gradually accumulated equity and reserves that served as capital buffers but also represented the accumulated patrimony of the institution. Without the pressure to pay dividends to stockholders, cooperative banks and savings banks may use retained profits for funding. Development banks and special purpose banks may receive equity endowments or deposits from governments or funds managed by govalternative banks with a variety of competitive advantages over private banks. In turn, these competitive advantages provide comparative advantages to social and political forces, local communities, alternative bank group members and regional and national governments.Because cooperative banks need only to remunerate the part of their equity represented by member shares, they may mobilize and retain capital and reach comfortable levels of liquidity, high deposit-to-loan ratios and Low pay-out ratios mean that cooperative banks (and, one may add, public savings and development banks) “can enjoy rapid growth in their capital base and therefore fast orggrowth” (Fonteyne, 2007: 47). Altunbas et al. (2001) suggest that the superior performance of cooperative banks and public banks over private banks can be explained by lower funding costs due to their different deposit bases and reliance on “less intecustomers.

Traditionally, cooperatives and mutual savings banks were less able than jointbanks to raise external capital through sale of shares.deposit base provided a good alternacapital markets at investment grade ratings on terms equal to the best private banks. We have mentioned the competitive advantages of sthe greater trust of customers in alternative banks as competitive advantages (Fonteyne, 2007;23 Kay, 1991). Furthermore, have accumulated greater capital reserves through more cautious, longer term policies of sustainable returns and large buffers against losses, these institutions retained a “patrimonial advantage” during transition to Basel II and III accords.

22 One should however cite an important caveat here: in several countries over the past decade or so, large savings and cooperative banks have been ablefunding instruments (with a varying degree of success: see the fate of Natixis in France as an edifying example). 23 the same author warns that this characteristic could actually turn into a liability as it cooperative banks more dependent on a specific category of customers. 24 This is a promising line of research that has not, to our knowledge, been explored.


32

been mitigated by network integration, peer pressure and corporate cultures as emphasized

In sum, alternative banks retain unique two-tier structures that combine independent local and regional retail banking institutions and shared wholesale operations, providing alternative banks significant advantages in terms of economies of scale while preserving and indeed deepening retail relationship banking.

7. Alternative bank funding, equity, reserves and patrimony

Alternative banks also fund operations, manage equity, and hold reserves and patrimony in ways fundamentally different than private banks. As indicated above in the section on alternative banking history, cooperative banks and savings banks gradually accumulated equity and reserves that served as capital buffers but also represented the accumulated

Without the pressure to pay dividends to stockholders, cooperative banks and savings banks may use retained profits for funding. Development banks and special purpose banks may receive equity endowments or deposits from governments or funds managed by governments. These different funding sources provide alternative banks with a variety of competitive advantages over private banks. In turn, these competitive advantages provide comparative advantages to social and political forces, local

tive bank group members and regional and national governments.Because cooperative banks need only to remunerate the part of their equity represented by

, they may mobilize and retain capital and reach comfortable levels of liquidity, loan ratios and be net lenders on the interbank market (Fonteyne, 2007).

out ratios mean that cooperative banks (and, one may add, public savings and development banks) “can enjoy rapid growth in their capital base and therefore fast orggrowth” (Fonteyne, 2007: 47). Altunbas et al. (2001) suggest that the superior performance of cooperative banks and public banks over private banks can be explained by lower funding costs due to their different deposit bases and reliance on “less interest rate sensitive” retail

Traditionally, cooperatives and mutual savings banks were less able than jointbanks to raise external capital through sale of shares.22 However, their long history and stable deposit base provided a good alternative, while shared wholesale banking groups today tap capital markets at investment grade ratings on terms equal to the best private banks. We have mentioned the competitive advantages of strong retail market positions, loyal customers, and

st of customers in alternative banks as competitive advantages (Fonteyne, Furthermore, Giannola (2009) argues that because alternative banks

have accumulated greater capital reserves through more cautious, longer term policies of nable returns and large buffers against losses, these institutions retained a “patrimonial

advantage” during transition to Basel II and III accords.24

One should however cite an important caveat here: in several countries over the past decade or so, large savings and cooperative banks have been able and willing to list specialized subsidiaries and funding instruments (with a varying degree of success: see the fate of Natixis in France as an edifying

the same author warns that this characteristic could actually turn into a liability as it cooperative banks more dependent on a specific category of customers.

This is a promising line of research that has not, to our knowledge, been explored.


been mitigated by network integration, peer pressure and corporate cultures as emphasized

tier structures that combine independent local and regional retail banking institutions and shared wholesale operations, providing

e while preserving and

Alternative banks also fund operations, manage equity, and hold reserves and patrimony in private banks. As indicated above in the section on

alternative banking history, cooperative banks and savings banks gradually accumulated equity and reserves that served as capital buffers but also represented the accumulated

Without the pressure to pay dividends to stockholders, cooperative banks and savings banks may use retained profits for funding. Development banks and special purpose banks may receive equity endowments or deposits from

ernments. These different funding sources provide alternative banks with a variety of competitive advantages over private banks. In turn, these competitive advantages provide comparative advantages to social and political forces, local

tive bank group members and regional and national governments. Because cooperative banks need only to remunerate the part of their equity represented by

, they may mobilize and retain capital and reach comfortable levels of liquidity, be net lenders on the interbank market (Fonteyne, 2007).

out ratios mean that cooperative banks (and, one may add, public savings and development banks) “can enjoy rapid growth in their capital base and therefore fast organic growth” (Fonteyne, 2007: 47). Altunbas et al. (2001) suggest that the superior performance of cooperative banks and public banks over private banks can be explained by lower funding

rest rate sensitive” retail

Traditionally, cooperatives and mutual savings banks were less able than joint-stock However, their long history and stable

tive, while shared wholesale banking groups today tap capital markets at investment grade ratings on terms equal to the best private banks. We have

trong retail market positions, loyal customers, and st of customers in alternative banks as competitive advantages (Fonteyne,

Giannola (2009) argues that because alternative banks have accumulated greater capital reserves through more cautious, longer term policies of

nable returns and large buffers against losses, these institutions retained a “patrimonial

One should however cite an important caveat here: in several countries over the past decade or so, and willing to list specialized subsidiaries and

funding instruments (with a varying degree of success: see the fate of Natixis in France as an edifying

the same author warns that this characteristic could actually turn into a liability as it makes

This is a promising line of research that has not, to our knowledge, been explored.

Fonteyne (2007) argued that the cost of capital will lose relevance in the overall cost of providing retail financial services in the near futurewill lose saliency as a source of competitive advantage). But he wrote before the 2007Given the very costly re-capitalization of (mostly private) banks throughoutwhether as regulatory requirement or prudential strategy, being able to access capital at a low cost seems likely to remain a fundamental source of competitive advantage in banking. This runs counter to the claim of Rasmussen (1988) that mutualand therefore depositor choice of mutual banks turns on confidence in mutual managers to pick a safer portfolio. This is where the peculiar “historical embeddedness” of alternative banks’ business models becomes important.

8. The sustainable business models of alternative banks

Both the fruits of relationship lending and the access to capital at a lower cost might actually be a curse to alternative banks. Hart and Moore (1998) thus argue that institutions maximizing consumer surplus (and not profit), such as cooperatives, will distribute this surplus to customers through price subsidies (interest rate subsidies in the case of cooperative financial institutions). This may distort decisions and lead to inefficient outcomes. Canning et al. (2003), however, suggest that credit rationing might be a more optimal solution for distribution of consumer surpluses. In discussing financial institutions, Canning et al. (2003) mention the possibmight have an advantage in “achieving economically efficient outcomes.” However, they attribute this to market failures and monopoly power in general. underestimate the dynamic outcomes of the capacity to be provide more sustainable bases for credit relationships over time.

Stakeholder-oriented governance, nonindependent retail operations and branch office networks embedded increate a unique set of incentives and constraints that shape alternative bank behavior. Their loyal retail base and the high level of trust they elicit also support a more sustainable business model. These characteristics of alternativemembership on corporate boards and in executive and managerial positions. This reinforces longer-term strategies and higher stability of earnings (Bongini and Ferri, 2007). Alternative bank aversion to short-term profit maximization helps explain better longAccording to Iannota et al. (2007), risk aversion produces higher loan quality in alternative bank portfolios. Alternative banks tend to concentrate activities in more traditional areas of banking. This provides alternative banks with more stable sources of revenue. On the other hand, the lower revenue diversification of alternative banks helps increase systemic stability, as discussed in the literature on diversity above. In fact, lower revthan offsets [alternative bank] lower profitability and capitalization” (Hesse and Cihak, 2007). In addition, increased stability reduces greater cost-efficiency in alternatiLower income diversification also helps explain alternative bank performance in terms of risk management.

Again, in recent decades, banks have diversified away from traditional banking (collecting deposits and making loans) on both sides of the balance sheet. On the liability side, diversification and expansion have made banks much more reliant on external funding sources. Contemporary banking theory asserts that “deposit financing makes banks vulnerable to runs” (Bhattacharya & Thakor, 1993). However, the 2007


33

Fonteyne (2007) argued that the cost of capital will lose relevance in the overall cost tail financial services in the near future (and therefore a lower cost of capital

will lose saliency as a source of competitive advantage). But he wrote before the 2007capitalization of (mostly private) banks throughout

whether as regulatory requirement or prudential strategy, being able to access capital at a low cost seems likely to remain a fundamental source of competitive advantage in banking. This runs counter to the claim of Rasmussen (1988) that mutual managers will not minimize costs and therefore depositor choice of mutual banks turns on confidence in mutual managers to pick a safer portfolio. This is where the peculiar “historical embeddedness” of alternative banks’ business models becomes important.

8. The sustainable business models of alternative banks

Both the fruits of relationship lending and the access to capital at a lower cost might actually be a curse to alternative banks. Hart and Moore (1998) thus argue that institutions

mer surplus (and not profit), such as cooperatives, will distribute this surplus to customers through price subsidies (interest rate subsidies in the case of cooperative financial institutions). This may distort decisions and lead to inefficient outcomes. Canning et al. (2003), however, suggest that credit rationing might be a more optimal solution for distribution of consumer surpluses. In discussing the optimizing decisions of notfinancial institutions, Canning et al. (2003) mention the possibility that alternative banks

achieving economically efficient outcomes.” However, they attribute this to market failures and monopoly power in general. These arguments underestimate the dynamic outcomes of the business model of alternative banks; and their capacity to be provide more sustainable bases for credit relationships over time.

oriented governance, non-profit missions, social mandates and independent retail operations and branch office networks embedded in local communities create a unique set of incentives and constraints that shape alternative bank behavior. Their loyal retail base and the high level of trust they elicit also support a more sustainable business

These characteristics of alternative banks generate greater stability in terms of membership on corporate boards and in executive and managerial positions. This reinforces

term strategies and higher stability of earnings (Bongini and Ferri, 2007). Alternative rm profit maximization helps explain better long

According to Iannota et al. (2007), risk aversion produces higher loan quality in alternative Alternative banks tend to concentrate activities in more traditional areas of

banking. This provides alternative banks with more stable sources of revenue. On the other hand, the lower revenue diversification of alternative banks helps increase systemic stability, as discussed in the literature on diversity above. In fact, lower revenue diversification “more than offsets [alternative bank] lower profitability and capitalization” (Hesse and Cihak, 2007). In addition, increased stability reduces losses from credit risk, which may explain findings of

efficiency in alternative banks (Gurtner et al., 2002, for French coop banks).Lower income diversification also helps explain alternative bank performance in terms of risk

Again, in recent decades, banks have diversified away from traditional banking eposits and making loans) on both sides of the balance sheet. On the liability side,

diversification and expansion have made banks much more reliant on external funding sources. Contemporary banking theory asserts that “deposit financing makes banks

able to runs” (Bhattacharya & Thakor, 1993). However, the 2007-8 crisis surely


Fonteyne (2007) argued that the cost of capital will lose relevance in the overall cost (and therefore a lower cost of capital

will lose saliency as a source of competitive advantage). But he wrote before the 2007-8 crisis. capitalization of (mostly private) banks throughout the world,

whether as regulatory requirement or prudential strategy, being able to access capital at a low cost seems likely to remain a fundamental source of competitive advantage in banking. This

managers will not minimize costs and therefore depositor choice of mutual banks turns on confidence in mutual managers to pick a safer portfolio. This is where the peculiar “historical embeddedness” of alternative

Both the fruits of relationship lending and the access to capital at a lower cost might actually be a curse to alternative banks. Hart and Moore (1998) thus argue that institutions

mer surplus (and not profit), such as cooperatives, will distribute this surplus to customers through price subsidies (interest rate subsidies in the case of cooperative financial institutions). This may distort decisions and lead to inefficient outcomes. Canning et al. (2003), however, suggest that credit rationing might be a more optimal solution

optimizing decisions of not-for-profit ility that alternative banks

achieving economically efficient outcomes.” However, they These arguments

alternative banks; and their capacity to be provide more sustainable bases for credit relationships over time.

profit missions, social mandates and local communities

create a unique set of incentives and constraints that shape alternative bank behavior. Their loyal retail base and the high level of trust they elicit also support a more sustainable business

banks generate greater stability in terms of membership on corporate boards and in executive and managerial positions. This reinforces

term strategies and higher stability of earnings (Bongini and Ferri, 2007). Alternative rm profit maximization helps explain better long-term performance.

According to Iannota et al. (2007), risk aversion produces higher loan quality in alternative Alternative banks tend to concentrate activities in more traditional areas of

banking. This provides alternative banks with more stable sources of revenue. On the other hand, the lower revenue diversification of alternative banks helps increase systemic stability,

enue diversification “more than offsets [alternative bank] lower profitability and capitalization” (Hesse and Cihak, 2007).

losses from credit risk, which may explain findings of ve banks (Gurtner et al., 2002, for French coop banks).

Lower income diversification also helps explain alternative bank performance in terms of risk

Again, in recent decades, banks have diversified away from traditional banking eposits and making loans) on both sides of the balance sheet. On the liability side,

diversification and expansion have made banks much more reliant on external funding sources. Contemporary banking theory asserts that “deposit financing makes banks

8 crisis surely

suggests that wholesale funding (financing banks on capital markets) may increase instability (Hardie and Howarth, 2013; Huang and Ratnovski, 2011). Given these different views,comparisons of the liability risks of alternative banks and private banks are required. On the asset side, contemporary banking theory also expected markets to reduce risk: “both theory and evidence support the expectation that risks should be rincreased should banks be permitted to engage in securities, insurance and other services” (Benston, 1994). This view has also lost credibility since the 2008 banking crisis(2010:26) shows that in a study of a sample of Europbanking activities increases banks’ tail betas and thus reduces banking system stability because interest income is less risky than all other revenue streams.”

There is also evidence that increased reliance on feerevenue volatility – so that income diversification actually increases, rather than decreases risk as profit variance (DeYoung and Roland, 2001; Stiroh, 2004; De Jonghe, 2010). DeYoung and Roland, in particular, show that for Ubanks shifting to non-interest bearing activities) has led to higher revenue volatility, compensated for by a higher level of revenues for European small banks show similar results, i.e. that income diversification increases risk (Mercieca et al., 2007); De Jonghe shows that for European listed banks, income diversification increases systemic bank risk measured as tail beta, that is the likelihood that extreme negative swings in bank stock will be linked to negative swings in bank indexes. By contrast, Chiorazzo et al. (2008) find a positive relationship between increased reliance on non-interest income and risk-adjusted returns for small Italian banks. diversification to noninterest income is related to lower profits and higher risks in the U.S. banking industry.

So it can be argued that one of the reasons for greater stability and better overall performance of alternative banks is outcome of their specific governance and business model and, perhaps, their smaller average size (except for development banks). “originate-to-distribute” model and retained traditional “originateoriginate-to-distribute model creates serious pitfalls. Banks selling loans on the secondary market face issues of adverse selection and moral hazard (Berndt and Gupta, 2009). Berndt and Gupta also show that banks actively engaged in loan selling on secondary markets underperform their peers by about 9 per cent a year in terms of riskreturns. They conclude that the originateThis result is hard to reconcile with standard theory that “in equilibrium, banks with private information cannot systematically take advantage of outside investors” (Duffee, 2009). Stakeholder-based banks, which have a higher propensity to remato-hold model, have thereby been found to exhibit higher earnings stability as well (Coco and Ferri, 2010).

9. Alternative banks help smooth inter

Allen and Gale (1997) argue that one key comparative advantage ocapital markets is their ability to smooth intercapital in good times and use it in bad times. As Ayadi et al. point out, “Creating and unlocking reserves is a specific technique of risk extension of the liquidity creation thesis (Diamond and Rajan, 2000), according to which access to refinancing at low cost and the ability of banks to enforce repayment or liquidate


34

suggests that wholesale funding (financing banks on capital markets) may increase instability (Hardie and Howarth, 2013; Huang and Ratnovski, 2011). Given these different views,comparisons of the liability risks of alternative banks and private banks are required. On the asset side, contemporary banking theory also expected markets to reduce risk: “both theory and evidence support the expectation that risks should be reduced rather than increased should banks be permitted to engage in securities, insurance and other services” (Benston, 1994). This view has also lost credibility since the 2008 banking crisis(2010:26) shows that in a study of a sample of European banks: “the shift to nonbanking activities increases banks’ tail betas and thus reduces banking system stability because interest income is less risky than all other revenue streams.”

There is also evidence that increased reliance on fee-based income leads to higher so that income diversification actually increases, rather than decreases

risk as profit variance (DeYoung and Roland, 2001; Stiroh, 2004; De Jonghe, 2010). DeYoung and Roland, in particular, show that for US commercial banks, an increase in product mix (i.e.

interest bearing activities) has led to higher revenue volatility, compensated for by a higher level of revenues (as a risk premium). Recent empirical evidence

anks show similar results, i.e. that income diversification increases risk (Mercieca et al., 2007); De Jonghe shows that for European listed banks, income diversification increases systemic bank risk measured as tail beta, that is the likelihood that

me negative swings in bank stock will be linked to negative swings in bank indexes. By contrast, Chiorazzo et al. (2008) find a positive relationship between increased reliance on

adjusted returns for small Italian banks. Stirodiversification to noninterest income is related to lower profits and higher risks in the U.S.

So it can be argued that one of the reasons for greater stability and better overall performance of alternative banks is their lower revenue diversification, which is the direct outcome of their specific governance and business model and, perhaps, their smaller average size (except for development banks). This also explains why alternative banks resisted the

stribute” model and retained traditional “originate-to-hold” models. The distribute model creates serious pitfalls. Banks selling loans on the secondary

market face issues of adverse selection and moral hazard (Berndt and Gupta, 2009). Berndt and Gupta also show that banks actively engaged in loan selling on secondary markets underperform their peers by about 9 per cent a year in terms of risk-adjusted abnormal returns. They conclude that the originate-to-distribute model might not be socially This result is hard to reconcile with standard theory that “in equilibrium, banks with private information cannot systematically take advantage of outside investors” (Duffee, 2009).

based banks, which have a higher propensity to remain faithful to the originatehold model, have thereby been found to exhibit higher earnings stability as well (Coco and

9. Alternative banks help smooth inter-temporal risk

Allen and Gale (1997) argue that one key comparative advantage of banks with respect to capital markets is their ability to smooth inter-temporal risk. Banks are able to accumulate capital in good times and use it in bad times. As Ayadi et al. point out, “Creating and unlocking reserves is a specific technique of risk management” (2010: 108). This argument is an extension of the liquidity creation thesis (Diamond and Rajan, 2000), according to which access to refinancing at low cost and the ability of banks to enforce repayment or liquidate


suggests that wholesale funding (financing banks on capital markets) may increase instability (Hardie and Howarth, 2013; Huang and Ratnovski, 2011). Given these different views, further comparisons of the liability risks of alternative banks and private banks are required. On the asset side, contemporary banking theory also expected markets to reduce risk: “both

educed rather than increased should banks be permitted to engage in securities, insurance and other services” (Benston, 1994). This view has also lost credibility since the 2008 banking crisis. De Jonghe

the shift to non-traditional banking activities increases banks’ tail betas and thus reduces banking system stability

based income leads to higher so that income diversification actually increases, rather than decreases

risk as profit variance (DeYoung and Roland, 2001; Stiroh, 2004; De Jonghe, 2010). DeYoung S commercial banks, an increase in product mix (i.e.

interest bearing activities) has led to higher revenue volatility, (as a risk premium). Recent empirical evidence

anks show similar results, i.e. that income diversification increases risk (Mercieca et al., 2007); De Jonghe shows that for European listed banks, income diversification increases systemic bank risk measured as tail beta, that is the likelihood that

me negative swings in bank stock will be linked to negative swings in bank indexes. By contrast, Chiorazzo et al. (2008) find a positive relationship between increased reliance on

Stiroh (2004) finds that diversification to noninterest income is related to lower profits and higher risks in the U.S.

So it can be argued that one of the reasons for greater stability and better overall their lower revenue diversification, which is the direct

outcome of their specific governance and business model and, perhaps, their smaller average This also explains why alternative banks resisted the

hold” models. The distribute model creates serious pitfalls. Banks selling loans on the secondary

market face issues of adverse selection and moral hazard (Berndt and Gupta, 2009). Berndt and Gupta also show that banks actively engaged in loan selling on secondary markets

adjusted abnormal distribute model might not be socially desirable.

This result is hard to reconcile with standard theory that “in equilibrium, banks with private information cannot systematically take advantage of outside investors” (Duffee, 2009).

in faithful to the originate-hold model, have thereby been found to exhibit higher earnings stability as well (Coco and

f banks with respect to Banks are able to accumulate

capital in good times and use it in bad times. As Ayadi et al. point out, “Creating and unlocking This argument is an

extension of the liquidity creation thesis (Diamond and Rajan, 2000), according to which access to refinancing at low cost and the ability of banks to enforce repayment or liquidate

bad loans are key determinants of banks creating liquidity. This is the theoretical basis for our claim that greater client confidence and trust in alternative banks provide a competitive advantage over private banks. While clients tend to withdraw deposits from the private bank sector during banking crises, deposits allegedly during difficult times. This reinforces the capacity of alternative banks to provide countercyclical lending. In other words, alternative banks are ideally positionetemporal risk smoothing function (Ayadi et al., 2010).

This ability can be explained by several factors. First, as mentioned, alternative banks benefit from greater trust from their depositors because of their history, more stable governance, social mandates and prudent behavior. Secondtrust, for instance through crossthese agreements were dropped by 2005 under pressure from European Communitcompetition rulings. Nonetheless, because of greater trust, alternative banks still appear able to accumulate capital more quickly through their extensive retail deposit base times. In a related argument, Berlin and Mester (1998) show thatdeposits allow for inter-temporal smoothing in lending rates.

Secondly, alternative bank capital is different from jointdoes not belong to the “current cohort of members” (Ayadi et al., 2010).viewed as an “owner-less intergenerational endowment that is available for use by current members, under the implicit or explicit understanding that they will grow it further and pass it on to the next generation of members.” (Fonteyne, 2007: 4) are under no pressure to those resources on the market capital markets put on joint-stock banks (Allen and Gale, 2000), in line with the free cash flow problem evoked earlier. Indeed, as incentives to disclose and their reserves in good times since it is financially profitable for the firm even as it is not socially desirable; by contrast, public banks, savings banks or cooperative banks do not have any incentive to these reserves.

Thirdly, inter-temporal risk smoothing is also linked to relationship banking. As reminded by Boot (2000), the durability of the bankcredit availability, especially for young firms or borrowers without credit history: indeed, the losses undergone by banks at the outset of the banking relationship, which constitute a form of credit subsidy (Petersen and Rajan, 1994), are recouped over time as the relationship unfolds, in terms of better soft information and trust.

Conclusion We explain the apparent anomaly of alternative bank performance since liberalization, privatization, demutualization, deregulation and crisis with theories and concepts taken from banking studies, past research on nonfoundations of competitive advantage. This implies going beyond standard approaches for comparison of alternative banks with private banks based on neotheories of the firm such as property rights theory and agency theory. As Biondi (2007:257) argues, “the interaction of the parts is not sufficient to understand the durable existence and functioning of the firm-entity.”

We have therefore expanded the scopframework to explore multiple facets of alternative banks.contemporary banking theory, we thereby begin account for the emergence and persistence of alternative banks. Our framew


35

ts of banks creating liquidity. This is the theoretical basis for our claim that greater client confidence and trust in alternative banks provide a competitive

While clients tend to withdraw deposits from the private bank deposits allegedly increase within the alternative bank sector

during difficult times. This reinforces the capacity of alternative banks to provide countercyclical lending. In other words, alternative banks are ideally positioned to perform the intertemporal risk smoothing function (Ayadi et al., 2010).

This ability can be explained by several factors. First, as mentioned, alternative banks benefit from greater trust from their depositors because of their history, more stable

vernance, social mandates and prudent behavior. Second-tier organizations also strengthen trust, for instance through cross-guarantee schemes (Coco & Ferri, 2010), although most of these agreements were dropped by 2005 under pressure from European Communitcompetition rulings. Nonetheless, because of greater trust, alternative banks still appear able to accumulate capital more quickly through their extensive retail deposit base

In a related argument, Berlin and Mester (1998) show that rate-insensitive core temporal smoothing in lending rates.

Secondly, alternative bank capital is different from joint-stock bank equity, in that it does not belong to the “current cohort of members” (Ayadi et al., 2010). Indeed

less intergenerational endowment that is available for use by current members, under the implicit or explicit understanding that they will grow it further and pass it on to the next generation of members.” (Fonteyne, 2007: 4) In addition, alternative banks are under no pressure to those resources on the market – precisely the kind of pressure that

stock banks (Allen and Gale, 2000), in line with the free cash flow problem evoked earlier. Indeed, as pointed out in Ayadi et al. (2009), jointincentives to disclose and their reserves in good times since it is financially profitable for the firm even as it is not socially desirable; by contrast, public banks, savings banks or

banks do not have any incentive to these reserves. temporal risk smoothing is also linked to relationship banking. As

reminded by Boot (2000), the durability of the bank-borrower relationship positively affects lly for young firms or borrowers without credit history: indeed, the

losses undergone by banks at the outset of the banking relationship, which constitute a form of credit subsidy (Petersen and Rajan, 1994), are recouped over time as the relationship

ds, in terms of better soft information and trust.

We explain the apparent anomaly of alternative bank performance since liberalization, privatization, demutualization, deregulation and crisis with theories and concepts taken from

ies, past research on non-profit firms, and heterodox theories of institutional foundations of competitive advantage. This implies going beyond standard approaches for comparison of alternative banks with private banks based on neo-institutional economic heories of the firm such as property rights theory and agency theory. As Biondi (2007:257)

argues, “the interaction of the parts is not sufficient to understand the durable existence and entity.”

We have therefore expanded the scope of inquiry and adopted a more comprehensive framework to explore multiple facets of alternative banks. Drawing on various strands of contemporary banking theory, we thereby begin account for the emergence and persistence of alternative banks. Our framework suggests that (a) banks, be they alternative or not, serve


ts of banks creating liquidity. This is the theoretical basis for our claim that greater client confidence and trust in alternative banks provide a competitive

While clients tend to withdraw deposits from the private bank within the alternative bank sector

during difficult times. This reinforces the capacity of alternative banks to provide counter-d to perform the inter-

This ability can be explained by several factors. First, as mentioned, alternative banks benefit from greater trust from their depositors because of their history, more stable

tier organizations also strengthen guarantee schemes (Coco & Ferri, 2010), although most of

these agreements were dropped by 2005 under pressure from European Community competition rulings. Nonetheless, because of greater trust, alternative banks still appear able to accumulate capital more quickly through their extensive retail deposit base – even in hard

insensitive core

stock bank equity, in that it Indeed it can be

less intergenerational endowment that is available for use by current members, under the implicit or explicit understanding that they will grow it further and pass

In addition, alternative banks precisely the kind of pressure that

stock banks (Allen and Gale, 2000), in line with the free cash flow pointed out in Ayadi et al. (2009), joint-stock banks have

incentives to disclose and their reserves in good times since it is financially profitable for the firm even as it is not socially desirable; by contrast, public banks, savings banks or

temporal risk smoothing is also linked to relationship banking. As borrower relationship positively affects

lly for young firms or borrowers without credit history: indeed, the losses undergone by banks at the outset of the banking relationship, which constitute a form of credit subsidy (Petersen and Rajan, 1994), are recouped over time as the relationship

We explain the apparent anomaly of alternative bank performance since liberalization, privatization, demutualization, deregulation and crisis with theories and concepts taken from

profit firms, and heterodox theories of institutional foundations of competitive advantage. This implies going beyond standard approaches for

institutional economic heories of the firm such as property rights theory and agency theory. As Biondi (2007:257)

argues, “the interaction of the parts is not sufficient to understand the durable existence and

more comprehensive Drawing on various strands of

contemporary banking theory, we thereby begin account for the emergence and persistence ork suggests that (a) banks, be they alternative or not, serve

a much broader range of stakeholders than shareholders alone; (b) accordingly, banks, regardless of their core mission (for(shareholder- or stakeholder-oriented) serve a much broader set of purposes than usually assigned to them in the literature on banking (reducing information asymmetries between lenders or borrowers); (c) key features of modern banking (such as relationship lending) emphasize the nature of interdependencies between banks and their immediate environments as constitutive characteristics of banking; (d) bank involvement in intertemporal dynamics (especially smoothing interstability of their operations at the heart of their business.

These four features, the last one in particular, not only help us to better understand the apparent anomaly of the emergence, survival and performance of alternative banks, they also prepare the grounds for a new theory of the banking firm. In terms similar to the reand re-interpretation of heterodox traditions in the theory of the firm (which have led to the conceptualization of the firm as an entity, Biondi et al., 2007), we therefore concluthere is need for an institutionalhighly interdependent institutions with broad social and economic mandates. This implies dealing with complex, essentially contested concepts about bankdifferent theoretical perspectives. We summarize these differences in Table 11. Table 11) Theories of banks as firms and theories of banks as institutions

Banks as

Firms

Governance Shareholder

Mission Profit maximization

Business model Manufacture assets

Strategy Maximize leverage

Risk management VaR or risk model

Theory Market equilibrium

Further research will be needed to flesh out this theoretical agenda. Another important area for future research lies in the changes in the standard criteria used to measure and compare performance across bank types. I“intermediate” between lenders and borrowers to generate market value for shareholders, then it makes sense to gauge their performance on other bases than standard measures of cost efficiency and profitability. In particulabout banks and systemic stability, resilience and interGiven the high cost of crisis, we need new ideas to counter the biases of banking studies toward private, market-based banking and the narrow focus of mainstream theories of the firm. Research on alternative banking seems especially promising for the development of new perspectives on banking and bank regulation.

The implication of these new perspectives on alternativeEuropeans have sorely underestimated the value of these institutions for averting the creation of asset bubbles, averting and ameliorating financial crises, accelerating recovery, and sustaining financial inclusion and more social ecoMarxists and liberals alike, alternative banks are the key to recovery in Europe.


36

a much broader range of stakeholders than shareholders alone; (b) accordingly, banks, regardless of their core mission (for-profit or non-for-profit) and their governance structure

oriented) serve a much broader set of purposes than usually assigned to them in the literature on banking (reducing information asymmetries between lenders or borrowers); (c) key features of modern banking (such as relationship lending)

phasize the nature of interdependencies between banks and their immediate environments as constitutive characteristics of banking; (d) bank involvement in intertemporal dynamics (especially smoothing inter-temporal risk) places the durability and

y of their operations at the heart of their business. These four features, the last one in particular, not only help us to better understand the

apparent anomaly of the emergence, survival and performance of alternative banks, they also for a new theory of the banking firm. In terms similar to the re

interpretation of heterodox traditions in the theory of the firm (which have led to the conceptualization of the firm as an entity, Biondi et al., 2007), we therefore conclu

institutional theory of banking: one that sees banks as socially embedded, highly interdependent institutions with broad social and economic mandates. This implies dealing with complex, essentially contested concepts about banks from two fundamentally different theoretical perspectives. We summarize these differences in Table 11.

Table 11) Theories of banks as firms and theories of banks as institutions

Institutions

Shareholder Stakeholder

Profit maximization Profit sustainability

Manufacture assets Balance assets and liabilities

Maximize leverage Moderate leverage

VaR or risk model Relationship banking & soft info.

Market equilibrium Uncertainty & institutions

Further research will be needed to flesh out this theoretical agenda. Another important area for future research lies in the changes in the standard criteria used to measure and compare performance across bank types. If banks, as we suggest, do more than simply “intermediate” between lenders and borrowers to generate market value for shareholders, then it makes sense to gauge their performance on other bases than standard measures of cost efficiency and profitability. In particular, progress toward assessing fundamental issues about banks and systemic stability, resilience and inter-temporal maturity transformation.Given the high cost of crisis, we need new ideas to counter the biases of banking studies

sed banking and the narrow focus of mainstream theories of the search on alternative banking seems especially promising for the development of new

perspectives on banking and bank regulation. The implication of these new perspectives on alternative banking suggest that

Europeans have sorely underestimated the value of these institutions for averting the creation of asset bubbles, averting and ameliorating financial crises, accelerating recovery, and sustaining financial inclusion and more social economies. Although despised in the past by Marxists and liberals alike, alternative banks are the key to recovery in Europe.


a much broader range of stakeholders than shareholders alone; (b) accordingly, banks, profit) and their governance structure

oriented) serve a much broader set of purposes than usually assigned to them in the literature on banking (reducing information asymmetries between lenders or borrowers); (c) key features of modern banking (such as relationship lending)

phasize the nature of interdependencies between banks and their immediate environments as constitutive characteristics of banking; (d) bank involvement in inter-

temporal risk) places the durability and

These four features, the last one in particular, not only help us to better understand the apparent anomaly of the emergence, survival and performance of alternative banks, they also

for a new theory of the banking firm. In terms similar to the re-discovery interpretation of heterodox traditions in the theory of the firm (which have led to the

conceptualization of the firm as an entity, Biondi et al., 2007), we therefore conclude that theory of banking: one that sees banks as socially embedded,

highly interdependent institutions with broad social and economic mandates. This implies s from two fundamentally

different theoretical perspectives. We summarize these differences in Table 11.

Table 11) Theories of banks as firms and theories of banks as institutions

Balance assets and liabilities

Relationship banking & soft info.

ncertainty & institutions

Further research will be needed to flesh out this theoretical agenda. Another important area for future research lies in the changes in the standard criteria used to measure and

s we suggest, do more than simply “intermediate” between lenders and borrowers to generate market value for shareholders, then it makes sense to gauge their performance on other bases than standard measures of

ar, progress toward assessing fundamental issues temporal maturity transformation.

Given the high cost of crisis, we need new ideas to counter the biases of banking studies sed banking and the narrow focus of mainstream theories of the

search on alternative banking seems especially promising for the development of new

banking suggest that Europeans have sorely underestimated the value of these institutions for averting the creation of asset bubbles, averting and ameliorating financial crises, accelerating recovery, and

nomies. Although despised in the past by Marxists and liberals alike, alternative banks are the key to recovery in Europe.

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APPENDICES Table 1) German Bank Balance Sheet Totals, Billion Euros, 1950

Private

Big Regional Foreign Savings

1950 3.904 2.513 4.1031960 14.650 13.744 28.7031970 42.726 44.559 6.159 95.9221980 115.207 127.593 22.763 265.3401990 239.568 409.801 39.007 552.5892000 969.783 613.223 121.407 953.9202010 2.082.896 735.097 203.673 1.082.870

Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/statistics.html?nsc=true. Accessed on 10February 2014 Table 2) Deposits by Type of Bank, Germany 1950

Private Coops

Big Regional Foreign Savings Regional

1950 1.280 0,823 - 0,541 1960 2.776 3.352 - 2.069 1970 8.785 14.812 5.026 7.643 1980 30.483 42.218 18.941 29.307 1990 63.929 187.833 32.854 76.114 2000 369.685 188.773 83.132 234.344 129.2142010 456.900 150.252 133.361 188.377 130.190

Source: Deutsche Bundesbank, available on www.bundesbank.de/NFebruary 2014


49

Table 1) German Bank Balance Sheet Totals, Billion Euros, 1950-2010 Coops Government

Savings Regional National Mortgage

B&L

Assoc

Special

Purpose

4.103 0,746 1.348 1.163 2.28128.703 3.628 7.238 22.060 13.32395.922 16.042 32.233 56.975 35.257

265.340 51.510 131.337 163.056 76.420552.589 110.790 302.615 312.510 255.426953.920 227.383 533.621 891.816 153.632 460.829

1.082.870 262.500 705.044 719.525 198.908 898.227Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/statistics.html?nsc=true. Accessed on 10

Table 2) Deposits by Type of Bank, Germany 1950-2010, billion euros Coops Government

Regional National Mortgage B&L Assoc Special

Purpose

0,609 0,346 0,18 0,6372.711 0,691 1.448 2.024

12.686 3.253 5.678 9.12639.698 17.639 26.549 27.27688.660 34.958 35.129 87.725

129.214 80.978 105.536 28.454 116.042130.190 99.632 225.684 30.293 158.409

Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/statistics.html?nsc=true. Accessed on 10

Landes-

2.281 2.307 13.323 17.446 35.257 65.055 76.420 195.575

255.426 389.486 460.829 1.222.704 898.227 1.463.536


Landes-

0,637 1.000 2.024 7.153 9.126 24.310

27.276 59.245 87.725 142.183

116.042 439.058 158.409 406.481

avigation/EN/Statistics/statistics.html?nsc=true. Accessed on 10

Table 3) Interest Spread by Type of German Bank, 1970

Private Coops

Year Big Regional Savings National

1970 2,67 2,04 2,75 0,84 1980 2,11 1,65 2,93 0,73 1990 2,32 1,81 2,67 0,66 2000 0,94 1,72 2,33 0,78 2010 0,95 1,69 2,20 0,48 Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/statistics.html?nsc=true. Accessed on 10 February 2014 Table 4) Interest Income as % Balance Sheet by Type of German Bank, 19682011

Private Coops

Year

Big Regional Savings Nationa

l

Regiona

1970 7,2 7,82 7,17 6,5 1980 8,55 8,5 7,65 7,82 1990 7,75 7,68 7,23 7,92 2000 5,24 5,58 5,72 5,04 2010 2,19 3,74 4,02 2,27

Source: Deutsche Bundesbank, available on www.bundesbank.deFebruary 2014


50

Table 3) Interest Spread by Type of German Bank, 1970-2010 Government

Regional Sp. Purpose Landes

3,52 0,99 0,69 3,29 0,68 0,58 2,95 0,7 0,61 2,45 0,45 0,56 2,33 0,44 0,68

on/EN/Statistics/statistics.html?nsc=true.

Table 4) Interest Income as % Balance Sheet by Type of German Bank, 1968-

Government

Regiona

l

Sp.

Purpose

Landes

7,88 5,08 6,38 8,24 6,53 7,25 7,56 6,46 7,33 5,69 5,81 5,63 4,03 4,47 3,21

Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/statistics.html?nsc=true. Accessed on 10 /Navigation/EN/Statistics/statistics.html?nsc=true. Accessed on 10

Figure 1) Pre-Tax Profits of Types of German Banks, 1968

Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/statistics.html?nFebruary 2014

-20.000

-10.000

0

10.000

20.000

19

68

19

69

19

70

19

71

19

72

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

Big banks

Landesbanken5

Cooperative banks


51

Tax Profits of Types of German Banks, 1968-2009

Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/statistics.html?n

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

Regional & Other Com. Banks Branches of foreign banks

Savings banks Regional Credit Cooperatives

Mortgage banks Special purpose banks


20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

Branches of foreign banks

Regional Credit Cooperatives

Table 5 – A synthesis of empirical comparisons of alternative bank performance

Study Main focus Countries

covered

Period of

observation

Ayadi et al. (2010)

Cooperative and commercial banks

7 European countries

2000-2008

Cornett et al. (2010)

State-owned and privately-owned banks

16 East Asian countries

1989-2004


52

A synthesis of empirical comparisons of alternative bank performance

observation

Units of

observation

Method Independent

variables

Dependent

variables

Sample of banks (total n. of 29,978 observations)

pooled OLS regression and a fixed effect panel regression

Bank type Measures of efficiency, profirisk: RoA, RoE, cost-ratio, earnings stability, regional growth, market power

Sample of 456 banks (of which 142 government-owned)

t-test; pooled cross-sectional and time-series regressions with error terms clustered at the firm level

Bank ownership

Several performmeasures: ROA & a modified ROA (precash flows / booktotal assets), capital ratios, NPLs

Dependent

variables

Main findings Data

sources

Measures of efficiency, profitability & risk: RoA, RoE,

-income ratio, earnings stability, regional growth, market power

Cooperative banks more profitable and in many cases more cost efficient, and more stable

Bankscope; national cooperative associations

Several performance measures: ROA & a modified ROA (pre-tax cash flows / book-value total assets), capital ratios, NPLs

Compared to state-owned banks, privately-owned banks are more profitable and better capitalized, have lower percentages of nonperforming loans

Bankscope; additional sources for ownership data


covered

Period of

observation

Ayadi et al. (2009)

Savings and commercial banks


1996-2006

Beck et al. (2009)


Germany 1995-2007

Bongini & Ferri (2008)


Italy 1995-1998

Garcia-Marco & Robles-Fernandez (2008)


Spain 1993-2000


53

observation

Units of

observation

Method Independent

variables

Dependent

variables

Sample of banks (19,139 observations)

Stochastic frontier based on a translog cost function

Bank type Measures of efficiency, profitability & risk: RoA, RoE, cost-ratio, earnings stability, regional growth, market power

Sample of 3,810 banks

Regressions; panel logit model

Bank type z-score, likelihood distress, nonperforming loan ratio

Sample of 211 banks

OLS regressions Bank type; Governance (board stability) & income diversification

Profit volatility (standard deviation of RoA)

Sample of 127 banks (total n. of 1,030 observations)

Dynamic panel data

Bank type Earnings stability (zscore) and solvency ratio

Dependent

variables

Main findings Data

sources

Measures of efficiency, profitability & risk: RoA, RoE,

-income ratio, earnings stability, regional growth, market

ower

No significant differences between savings and commercial banks in terms of efficiency & profitability. Slight advantages in terms of earnings stability

Bankscope; national savings banks associations

score, likelihood distress, non-performing loan ratio

Savings banks more stable than commercial banks

Deutsche Bundesbank

Profit volatility (standard deviation of RoA)

Cooperative banks show lower profit volatility than commercial banks

Bankscope

Earnings stability (z-score) and solvency ratio

Spanish savings banks less risky than commercial banks

Savings bank assoc., Spanish Sec. & Exchange Commission & Private Bank Assoc.


covered

Period of

observation

Cihak and Hesse (2007)


29 OECD countries

1994-2004

Iannotta et al. (2007)

Mutual & government-owned and commercial banks


1999-2004

Carbó Valverde et al. (2007)

Savings banks 1992-2001

Chakravrty & Williams (2006)


Germany 1999


54

observation

Units of

observation

Method Independent

variables

Dependent

variables

Sample of banks (16,577 observations)

Regression; panel model

Bank type Earnings stability (zscore)

Sample of 181 large banks

OLS regression Bank ownership

Cost efficiency, profitability, earnings stability (asset quality & zscore)

Sample of 77 commercial and savings banks

516 banks Stochastic frontier Bank ownership

Operating profit efficiency

Dependent

variables

Main findings Data

sources

Earnings stability (z-score)

Cooperative banks are more stable than commercial ones

Bankscope

Cost efficiency, profitability, earnings stability (asset quality & z-score)

Cooperative & government-owned banks slightly more cost-efficient, less profitable than commercial banks; mutual banks less risky, government-owned banks riskier

Bankscope

Operating profit efficiency

Commercial banks less profit efficient than non profit banks

Bankscope


covered

Period of

observation

Crespi et al. (2004)

Savings banks Spain 1986-2000

Altunbas et al. (2003)

Savings, cooperative and commercial banks

15 European countries + the US

1990-2000

Carbó Valverde et al. (2002)

Savings banks 12 European countries

1989-1996

Salas & Saurina (2002)


Spain 1983-1997

La Porta et al. (2002)

Government-owned banks

92 countries 1960-1995


55

observation

Units of

observation

Method Independent

variables

Dependent

variables

Sample of banks (total n. of observations: 2,105)

Multivariate regression

Bank ownership & governance mechanisms

RoA

Sample of banks (total n. of 25,841 observations)

Stochastic frontier & translog function

Bank ownership

Cost & profit efficiency

Sample of banks (total n. of observations: 4,083

Stochastic cost frontier

Bank size and country

Cost efficiencies

1,381 bank observations

Regression; panel data analysis

Bank type Risk (measured as the ratio of problem loans)

Country sample OLS regressions Country-wide degree of government ownership of banks

Financial development & economic growth

Dependent

variables

Main findings Data

sources

Savings banks more profitable than commercial banks

Savings Banks Association & Private Banks’ Association

Cost & profit efficiency

Commercial banks less cost efficient but more profit efficient than savings & cooperatives

Bankscope

Cost efficiencies

Smaller savings banks are more efficient than large ones

Bankscope

Risk (measured as the ratio of problem loans)

No significant difference between commercial and savings bankd

Central Bank

Financial development & economic growth

Government ownership of banks slows down financial development & growth

Various: Banker’s Almanach, Thomson Bank Directory, World Bank


covered

Period of

observation

Altunbas et al. (2001)

Cooperative and Savings banks

Germany 1989-1996

Valneck (1999)

Building societies & commercial banks

United Kingdom

1983-1993

Cole & Mehran (1998)

Thrift institutions

United States

1983-1995

Esty (1997)

Savings and Loans and commercial banks

United States

1982-88

Cebenoyan et al. (1993)

Savings and Loans

Atlanta, United States

1988

Mester (1993)

Savings and Loans

United States

1991

Source: Butzbach and Mettenheim, 2014, pp. 36-40


56

observation

Units of

observation

Method Independent

variables

Dependent

variables

7,539 bank-level observations

Stochastic frontier Bank ownership

Cost efficiency

Sample of 17 building societies & 7 banks

Parametric models

Bank ownership type

RoA, adjusted RoA, other earnings measures

Sample of 94 institutions

Ownership change

Stock performance (annual stock returns)

Sample of 2, 515 S&Ls

Parametric and non-parametric methods

Bank type Risk taking

Sample of 559 S&Ls

Stochastic cost frontier

Bank type

Sample of 1,0571 S&Ls

Stochastic frontier; parametric cost function

Bank ownership

Cost efficiency

40

Dependent

variables

Main findings Data

sources

Cost efficiency Slight cost and profit advantages for non-profit banks

Bankscope

RoA, adjusted RoA, other earnings measures

Mutual building societies outperform joint-stock retail banks

Bankscope

Stock performance (annual stock returns)

De-mutualized thrifts perform better than thrifts

Risk taking Stock thrifts show greater risk-taking than mutual thrifts

Federal Agency’s annual reports

Cost efficiency Joint-stock S&Ls are more efficient than mutual S&Ls

Alternative Banking and Recovery from Crisis

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