Distance and Efficiency in the Italian Banking System

During the last decades, banks have progressively moved towards largest, centralized and hierarchical organizational structures. An increased investment in non-interest generating activities has also implied performance vulnerability, whose effects have been particularly destabilizing during the recent financial crisis. In this economic and financial contest, several banks have become increasingly concerned with controlling and analyzing their costs and revenues, as well as measuring the risks taken to produce acceptable returns. In line with these developments, recent literature has evolved examining alternative banking organizational models, risk and efficiency issues (Kano et al., 2011; Berger and Black, 2011; Fiordelisi et al., 2011). With reference to efficiency, the level of attention has increased due to the growing complexity and competitiveness of the market, and different methodological approaches have been proposed to investigate financial bank efficiency (Bos et al., 2009; Fiordelisi et al. 2011). Among efficiency determinants, size, capital, risk and environmental factors reveal to be the most investigated; conversely at our knowledge no empirical studies have analyzed whether relationship lending features influence bank efficiency levels. In the literature distance, size and bank diversification attitudes are used as proxy of different bank organization structures, and indirectly of alternative relationships between bank and customers. Several factors – innovation, consolidation and regulation – have recently changed bank organizational structure making banks larger and more complex. Small business lending has also been affected. Technological innovations make easier SMEs evaluation via credit scoring; moreover, consolidation creates the opportunity for larger and more complex financial institutions to interact with SMEs differently than smaller and less complex institutions. Large and complex institutions are usually more distant and characterized by a different and more sophisticated product diversification. The effects of both these aspects on efficiency depend as suggested by Udell (2009) (p. 16) ’on the extent to which hard information about borrower quality is a good substitute for soft information. On the one hand, hard information is quantifiable and easily stored and can be produced and communicated over long distances. […] On the other hand, soft information cannot be easily stored; and it can neither be easily generated over long distances, nor be easily communicated over long distances or within large and complex banking organizations‘ (on this point see also Stein, 2002). As for distance, we refer to the so-called Church Tower Principle (CTP), proposed by Carling and Lundberg (2005, p. 40), affirming that ‘the bank is the church tower and from its outlook it can screen and monitor firms in its proximity.’ Authors refer to this as asymmetric information, which increases in distance. This principle appears to be particularly relevant for the Italian banking system, whose lending service is mainly addressed to SMEs being highly opaque. The distance between the bank headquarter (HQ) and its branches could exacerbate the loan evaluating process, affecting the overall bank efficiency negatively. The rationale is that as the distance between the borrowing firm and the bank loan decision unit increases, the relationship lending weakens and the firm credit evaluation process becomes problematic. Even if relationships between distance and efficiency, at our knowledge, has not been investigated, a large stream of the literature has conversely analysed the relation between organizational structure, distance and lending conditions. As suggested by Alessandrini et al. (2009c, p. 1) ‘technological progress, deregulation, and consolidation have deeply changed the geography of the banking industry in many countries’. In this respect it becomes important to understand the role of functional distance – defined...