Intra-Bank Electronic Capital Markets and Hierarchical Coordination: Searching for the Optimal Mixed Mode Banking Operation

Information technology (IT) is enabling financial services companies and particularly banking firms to create new forms of organizations. Both globalization of markets and more rigorous regulation throughout the European Union such as recently the implementation of the European Capital Adequacy Directive put pressure on the banking firm to either spend ever more money in coordinating business activities in the traditional hierarchical ways or to employ new forms of organizations enabled by (reduced costs of) IT. Holland et al. [1994] and Lockett and Holland [1996] have analyzed these developments. Our vision sketched in this paper is to partially substitute and partially complement hierarchical coordination with an Intra-Bank Electronic Capital Market. Observing that allocation of equity capital among decentral units in accordance with tightening regulation rules requires considerable effort, we analyze which suitable implementation of an internal electronic market for capital allocation compared to traditional hierachical coordination is most competitive. It turns out that depending on the crucial parameters of the banking firm pure market coordination or pure hierarchy coordination may be optimal. But in many relevant cases the optimal operation is mixed mode (as described by Holland and Lockett [1997]), i.e., part of the coordination problem is solved via the internal market while the remainder is done in a hierarchical manner. Thus, our analysis also constitutes a contribution to the „move to the market“ versus „move to the hierarchy“ debate in specifying when the „move to the middle“ solution is optimal in the analysis.