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Title: Bank Diversification and Incentives

Author(s): Gyöngyi Lóránth and Alan Morrison

Publication Date: November 2008

Keyword(s): Bank diversification, soft budget constraint, tying and universal banks

Programme Area(s): Financial Economics

Abstract: This paper analyzes the consequences of bank diversification into fee-based businesses. Universal banks raise welfare by expanding the range of services available to entrepreneurs. However, because they may choose to rescue failed entrepreneurs in order to sell them fee-based financial services, universal banks provide weaker incentives. Adopting a holding company structure and devolving liquidation decisions to the lending division partially resolves this problem. We demonstrate a relationship between the welfare effects of diversification and competition for fee-based business, and we analyze the tying of lending and fee-based business. Our analysis yields several testable implications.

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Bibliographic Reference

Lóránth, G and Morrison, A. 2008. 'Bank Diversification and Incentives'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7051