Cost and Profit Dynamics in Financial Conglomerates and Universal Banks in Europe

Abstract

In contrast to the U.S. where universal banking is legally prohibited, the Second Banking Directive has allowed European banks to form financial conglomerates and hold equity stakes in non-financial companies. The question is whether these conglomerates and universal banks are an efficient organizational structure. This paper analyzes the cost and profit efficiency of European banks subdivided according to their degree of diversification, conglomeration, and universality. We find that financial conglomerates are more revenue efficient than their more specialized competitors and that the degree of both cost and profit efficiency is higher in universal banks than in non-universal banks. These results indicate that the current trend towards further despecialization may lead to a more efficient banking system. Finally, the profit regressions show that operational efficiency has become the major determinant of bank profitability and that oligopolistic rents have become less prevalent in European banking.

JEL Classification: G21