Information Sensitivity and the Scope of Financial Intermediation

Abstract

We present a model of financial intermediation in which bank scope determines a lender's incentives to acquire information about the nature of a firm's moral-hazard problem. In the model, the lender's informedness is crucial for offering optimal financing contracts. We characterize the efficiency gains from contracting with an informed lender in terms of the firm's fundamentals, and explore coordination failures in information acquisition by multiple banks with heterogenous monitoring technologies. We develop a notion of firm-level information sensitivity to generate predictions about the firm-level effects of increasing the scope of banking. Highly volatile firms that are simultaneously highly productive are best placed to realize efficiency gains from contracting with banks offering a wide array of financial services. We propose the stepwise repeal of the Glass-Steagall Act in the U.S. during the 1990s as a suitable experiment that varied the scope of banking. Our key prediction is in line with the empirical record from this period. We use our framework to generate further empirical predictions regarding the structure of bank syndicates and the relationship between volatility and size.