Centralized and decentralized lending: Implications of consolidation in the German banking industry

Abstract

This paper addresses the implications of consolidation in the German banking industry regarding the operation of savings banks. Savings banks are one of the pillars of Germany’s banking system and the main providers of loans to small and medium firms that, in turn, are the predominant drivers of the economy. We develop a theoretical model showing that, by changing the organizational structure of savings banks from decentralized decision making (loan approval made by local officers) to centralized (loan approval at the headquarters), consolidation of the banking industry might lead financial institutions to ration credit in situations where such outcome would be unwarranted. The cause of this result is that delegated authority (decentralized structure) can make use of soft-information which otherwise would be neglected under a hierarchical arrangement (centralized structure).