Conglomeration Trends and Financial Risk Gianni De Nicol International Monetary Fund MAE Department

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Conglomeration Trends and Financial RiskGianni
De NicolóInternational Monetary FundMAE
Department
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Overview

• I present some preliminary findings of research
  in progress in the Monetary and Exchange Affairs
  Dept of the IMF
• Conglomeration facts
• Some evidence on conglomeration and financial
  risk
• Implications

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Data

• We consider the largest 500 financial
  institutions worldwide in 1995 and 2000
• Conglomerate a financial firm active in at least
  2 business lines

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Conglomeration facts

• Conglomeration among the largest 500 firms
  worldwide has increased both in terms of number
  of firms and assets held
• About 87 percent of conglomerates are led by
  banks
• The trend in conglomeration is global
  (industrialized and emerging market countries).

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Financial Risk

• Product diversification and efficiency gains may
  allow firms to choose LOWER RISK PROFILES
• Extension of safety-net to non-bank activities
  and more difficult supervision may allow firms to
  choose HIGHER RISK PROFILES
• What are the NET EFFECTS?

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Questions

• Do large financial firms exhibit levels of
  failure risk lower than small firms? NO
• Does failure risk of conglomerate and
  non-conglomerate firms differ? YES, (LARGE)
  CONGLOMERATES APPEAR TO BE RISKIER

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Why?

• The incentives for firms to take on more risk
  appear to have offset the risk reductions allowed
  by scope economies
• As noted, these incentives may be moral-hazard
  related, or
• Could be the result of increased market power?

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Measurement

• Z-index, a proxy measure of firms probability of
  failure
• (ROA E/A)/ ROA volatility
• ROA Return on Assets
• E/A Equity Capital to Asset Ratio

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Table 1 Statistics on Size Distribution of
Conglomerates and Non-conglomerates (in US
Billion)
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Cross-Sectional regressions

• Dependent variables
• Z-score and its components
• Z componentsROA, E/A and ROA volatility
• Regressors
• Conglomerate dummy
• Size of conglomerates and non-conglomerates
• Other controls

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Table 2 Regression Results on Risk, Size and
Conglomeration 1/
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What are the drivers of conglomeration?

• Search for efficiency and diversification
  improvements
• Search for market power
• Over-expansion of self-serving managers and other
  agency costs
• Moral-hazard related expansion of safety net
  subsidies (e.g. To Big to-Fail, to-Discipline,
  to- Monitor-Effectively, etc.)

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Policy responses

• The best response is to
• Choose the supervisory architecture that
  maximizes supervisory capacity
• Choose regulatory architecture that minimizes
  regulatory arbitrage
• Does the conglomeration trend imply
  conglomeration of supervision?