Economics in a picture
Portuguese banking groups scaled down their geographical complexity from 2014 to 2018
Geographical complexity refers to the span and scope of activities that banking groups manage across different countries or regions. On one hand, complexity may exacerbate moral hazard and agency problems. Complex banks may take too much risk (because they believe that they are too-big-to-fail) or may have risk taking incentives due to the misalignment of interests in their governance structure. On the other hand, complexity may be necessary to achieve a certain operating scale and thus be part of a bank’s business model without entailing more risk-taking.
Geographical complexity can be measured in many different ways. We consider four indicators that are relevant for Portuguese banking groups: the number of countries in which a banking group operates, the number of foreign affiliates (all branches and subsidiaries abroad), the number of foreign affiliates registered as banks, and the number of affiliates located in Africa. All these indicators showed a downward trend from 2014 to 2018, mostly concentrated in the first two years. This reflects the adjustment of the Portuguese banking sector in the aftermath of the euro area sovereign debt crisis.
When we consider the relationship between geographical complexity and banks’ risk, we find that the decrease in geographical complexity was accompanied by a decrease in banks’ risk indicators. This suggests that moral hazard and agency problems may be more acute when banks operate in a wide range of geographies.
For more details see Diana Bonfim and Sónia Félix (2020) “Banks' complexity and risk: agency problems and diversification benefits”, Banco de Portugal Working Paper 202010.
Prepared by Diana Bonfim and Sónia Félix. The analyses, opinions, and findings expressed above are those of the authors and do not necessarily coincide with those of Banco de Portugal or the Eurosystem.
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