Internal Capital Markets and Corporate Politics in A Banking Group

Internal Capital Markets and Corporate
Politics in a Banking Group

K. J. Martijn Cremers
Yale School of Management
Rocco Huang
Michigan State University and Wharton Financial Institutions Center
Zacharias Sautner
University of Amsterdam and Duisenberg School of Finance
We analyze proprietary internal capital allocation data from a large retail banking group
consisting of member banks and a headquarters organization. We find that capital alloca-
tions from headquarters compensate for deposit shortfalls on the bank level, suggesting
that the headquarters offers deposit smoothing to member banks. We then analyze how
the distribution of influence within the group relates to capital allocations and lending be-
havior. More influential banks are allocated more funds from headquarters, and their loan
growth is less sensitive to their deposit base. The effects of influence are stronger if banks
have a greater demand for deposit smoothing. (JEL G21, G31, G32)
Capital allocation within a firm or business group has not been widely studied
despite the central role of such allocations in corporate finance. This is partly
because data are hard to find. To improve our understanding of how internal
markets work in a bank, we analyze a proprietary internal capital allocation
dataset from a large retail banking group that consists of 181 member banks
We would like to thank Utpal Bhattacharya, Arnoud Boot, Murillo Campello, Paolo Fulghieri (the editor), John
Graham, Jean Helwege, Andrew Hertzberg, Rajkamal Iyer, Christel Karsten, Mark Leary, Vojislav Maksimovic,
Marco Pagano, Enrico Perotti, Tina Pedersen, Alexander Popov, David T. Robinson, David Scharfstein, Amit
Seru, Jeremy Stein, René Stulz, Manuel Utset, and two anonymous referees. We are also grateful for comments
from seminar participants at the 18th Mitsui Finance Symposium (at the University of Michigan), the American
Finance Association’s 2010 Annual Meeting in Atlanta, the 6th Annual Conference on Corporate Finance at
WUSTL, the 4th New York Fed/NYU Stern Conference on Financial Intermediation 2008, the Second Swiss
Conference on Banking and Financial Intermediation, the Florida State University Spring Beach Conference
2009, the Northern Finance Association Meetings 2009, the University of Amsterdam, Tilburg University, and
the University of Utah. All errors are our own. The article was completed while Rocco Huang was an economist
with the Federal Reserve Bank of Philadelphia. However, the views expressed herein do not necessarily repre-
sent those of the Federal Reserve Bank of Philadelphia or the Federal Reserve System. Send correspondence
to Zacharias Sautner, University of Amsterdam, Finance Group, Roetersstraat 11, 1018WB Amsterdam, The
Netherlands; telephone: +31-20-525-4325. E-mail: z.sautner@uva.nl.
c The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies.
All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org.
doi:10.1093/rfs/hhq121 Advance Access publication December 10, 2010
Internal Capital Markets and Corporate Politics in a Banking Group
and a headquarters organization.1 In this group’s internal capital market, mem-

ber banks can neither access the external capital market nor directly invest their
cash surpluses outside the firm. However, member banks can either invest their
funds in loans to customers in their local market or deposit surplus funds at
headquarters. Our data have been collected from the group’s internal manage-
rial accounting system, and allow us to directly observe not only the lending
and deposits of each member bank but also all capital transfers between the
headquarters and the banks. Moreover, the data allow us to create a measure of
each bank’s influence within the group to study the role of corporate politics
in internal capital allocations.
We use this unique dataset to investigate two issues. First, we study the func-
tioning of the group’s internal capital market, and analyze whether and how
internal capital allocations from headquarters can provide an intertemporal in-
surance function for member banks against deposit shortfalls. In particular,
we study whether headquarters provides a critical function by smoothing out
deposit shocks experienced by its member banks, thereby reducing the corre-
lation between investments (i.e., loans) and variations in local financing cash
flows (i.e., deposit growth).2
Second, we analyze how the distribution of member bank influence within
the group is related to the allocation of group resources. We also study how the
distribution of influence is related to the member banks’ lending behaviors and
the extent to which deposit smoothing by headquarters varies across banks with
different levels of influence. The analyses of the roles of influence in capital
allocation decisions are motivated by the broader literature on “socialist” ten-
dencies in internal capital markets. This literature indicates that there may be
cross-subsidizations from stronger to weaker units within a firm (e.g., Shin and
Stulz 1998; Rajan, Servaes, and Zingales 2000; Scharfstein and Stein 2000;
Gopalan, Nanda, and Seru 2007), and that capital allocation decisions are not
only based on investment opportunities of a unit, they may be partially based
on a unit’s influence or power within the firm. Glaser, Lopez-de-Silanes, and
Sautner (2010), for example, show that the distribution of cash windfalls within
an industrial conglomerate is based partly on the influence of managers, and
Duchin and Sosyura (2010) document how a unit’s social ties with the CEO
affect its investments. Using survey evidence from CEOs and CFOs, Graham,
Harvey, and Puri (2010) also provide some confirmation that corporate politics
1 The member banks operate in a highly developed and competitive banking market that is homogeneous in terms
of economic, social, and geographic particulars. Each member bank operates in a clearly defined local market.
The name of the banking group and the country of operation cannot be disclosed because of a confidentiality
agreement.
2 In measuring the sensitivity of loan growth to internal cash flow (i.e., deposit growth), we follow the recent
literature (e.g., Campello 2002; Houston, James, and Marcus 1997; Shin and Stulz 1998). In terms of the debate
in the literature (Fazzari, Hubbard, and Petersen 2000; Kaplan and Zingales 1997, 2000), we choose to be
agnostic on whether a correlation of loan growth and deposit growth implies inefficiency in the internal capital
market and focus instead on how the correlation varies with the influence of a bank.
359
The Review of Financial Studies / v 24 n 2 2011
and corporate socialism play a role in capital allocations within firms. We

discuss this literature in Section 3.
A bank’s relative influence in the group is measured by the divergence from
one share–one vote. The measure is computed as the ratio of a bank’s share of
voting rights divided by its share of ownership rights in the headquarters.3 A
member bank with a higher proportion of voting rights relative to its ownership
rights is perceived as more influential because it can bargain for more favors
relative to its ownership share.4 The ratio’s variation across banks is caused
partly by discontinuities in the allocation of voting rights. For example, the
number of votes can only be an integer between one and ten, while the number
of shares is basically continuous.
While influence and its role in corporate politics are usually subtle and tacit,
the banking group examined here has some more explicit influence channels
as well. For example, member banks can exercise influence at headquarters
by voting on the composition of the group’s supervisory board, which elects
the group’s executive board and sets the general strategy. Moreover, more in-
fluential banks are more likely to be represented in important committees at
headquarters—committees that make decisions on group policies and internal
relations.
In our empirical analysis, we document large and frequent internal loans to
member banks from headquarters. We also observe substantial transfers from
member banks to headquarters, which implies a significant reallocation of re-
sources within the group. The net funds from headquarters partially compen-
sate member banks for lower deposit growth, and member banks receive more
funds if investment opportunities are better.5 The finding that capital transfers
from headquarters compensate for deposit shortfalls suggests that headquar-
ters provides an intertemporal insurance function because variation in deposit
growth (particularly savings account deposits) is likely to be largely uncorre-
lated with variation in local loan demand.
Furthermore, more-influential banks are allocated more funds from head-
quarters. A one-standard-deviation increase in influence is associated with a
6.3% increase in net funds from headquarters (relative to total assets), which
is more than 50% of the cross-sectional standard deviation and about one-third
of the median ratio of net funds from headquarters relative to total assets.
3 Using the divergence from one share–one vote to measure disproportionate influence is common in the corporate
governance literature, which generally finds that voting rights in excess of ownership rights are associated with
private benefits. See, e.g., Claessens, Djankov, and Lang (2000), Doidge et al. (2009), Faccio and Lang (2002),
Harvey, Lins, and Roper (2001), Durnev and Kim (2004), La Porta, Lopez-de-Silanes, and Shleifer (1999, 2002),
Lemmon and Lins (2003), Lins (2003), and Leuz, Lins, and Warnock (2009).
4 As a result, our influence proxy has a strongly negative correlation with member bank size. We conduct extensive
robustness checks to mitigate concerns that this correlation drives our results. For example, we control for size
and ownership rights, remove the largest banks, and divide banks into size-based subsamples.
5 Net funds from headquarters are defined as the difference between loans from and deposits at headquarters.
Gopalan, Nanda, and Seru (2007) also used net funds in their analysis. Our results do not change if we look at
gross funds (loans) from headquarters instead.
360
Member banks’ loan growth is related to their own deposit growth. How-
ever, the correlation with deposit growth is quite small economically and be-
comes insignificant once we account for unobserved heterogeneity on the bank
level. Still, this small average effect masks the significantly different outcomes
for banks with high and low levels of influence. More specifically, the loan
growth of more-influential banks is much less sensitive to their own deposit
growth. This indicates that headquarters provides more deposit smoothing to
more influential banks. In contrast, less-influential banks are more constrained
by internal funding and therefore have to rely more on positive deposit growth
to increase their lending.6
We show that the effects of influence are stronger when banks have greater
demand for deposit smoothing, i.e., when the intertemporal insurance function
provided by headquarters seems most important. The need for deposit smooth-
ing is measured using several proxies. First, we categorize banks on the basis of
high and low deposit growth volatility. Highly volatile deposit growth creates
larger or more frequent funding gaps, which gives rise to more local funding
deficits and, consequently, greater demand for deposit smoothing by headquar-
ters. Second, we separate business lending from personal lending. Denials of
business loans because of a bank’s own temporary liquidity constraint may give
rise to larger long-term damages than denials of personal loans, because busi-
ness loans contain more soft information (Stein 2002). Therefore, the demand
for deposit smoothing is arguably greater for business lending. Finally, we in-
vestigate an event in 2007 that generated largely exogenous deposit inflows,
which (temporarily) significantly reduced the need for deposit smoothing by
headquarters across all banks. Across all three approaches, we find that more
influence is associated with a lower sensitivity of loan growth to deposit growth
when the demand for deposit smoothing is greater.
A major challenge in internal capital market research is to account for invest-
ment opportunities, which may differ across member banks. Changes in loan
growth could be driven by unobserved differences in local economic circum-
stances faced by different banks, and changes in local deposits may partially
reflect changes in lending opportunities. Several aspects of our empirical de-
sign allow us to mitigate such endogeneity concerns (see Section 1.4). First, the
banks within the group are very homogeneous in terms of their business model,
products, brands, and pricing policies. Second, we control for variations in lo-
cal market conditions by employing regional fixed effects that change each
quarter. Our results are also robust to the addition of bank fixed effects, which
account for time-invariant heterogeneity on the bank level. Third, we try to
control for investment opportunities using the banking group’s own internal
measure of member bank productivity, which is defined as income over costs.
6 Our results are robust to the inclusion of region-by-time fixed effects and member bank fixed effects, and to
separately controlling for voting rights and ownership rights. The use of region-by-time fixed effects means
that our results are obtained by comparing about a dozen member banks within narrowly defined geographical
regions in each time period to control for unobserved local market conditions.
361
The remainder of the article is structured as follows. The next section de-
scribes the group’s internal capital market, the data, and the methodology.
Section 2 presents the empirical results, and Section 3 discusses our results
relative to the existing literature. Our conclusions are presented in Section 4.
1. Institutional Background, Data, and Methodology

1.1 The Banking Group
The banking group analyzed in this article consists of 181 member banks
that jointly own a headquarters organization. All banks have ownership rights
(shares) and voting rights (votes) in the headquarters. Headquarters coordi-
nates the group and provides centralized back-office, marketing, and capital
market services. The member banks decide on the composition of the group’s
supervisory board, which elects the banking group’s executive board and sets
the group’s general strategy.
Each member bank operates in a clearly defined local market and is mutu-
ally owned by its local depositors. The management of each member bank is
appointed by a supervisory board that is elected by the depositors. All banks
in the group have an identical business model and brand, identical products
and marketing, and identical pricing schedules. Specifically, all member banks
offer the same rates for deposits and follow the same reference rates for loans
to customers.
The banking group’s stated goal is to maximize value for its members in
terms of disbursing regular profit-sharing dividends to them and serving their
financial interests. The government has no ownership or direct involvement in
the group.
1.2 The Internal Capital Market

Headquarters is responsible for the internal and external financing activities of
the group. To allocate resources within the organization, headquarters operates
an internal capital market, which allows member banks to manage funding
deficits and surpluses among themselves. Headquarters funds member banks
through internal loans, on which all member banks pay the same interest rates
regardless of their risk. Headquarters refinances itself by accessing the external
capital market and by collecting all funding surpluses from member banks.
Headquarters’ access to the external capital markets is very good, as evidenced
by its top credit rating and continued access to money markets during the recent
global financial crisis.
Member banks cannot access the external capital market, and they are not
allowed to invest their cash surpluses outside the group. They can either in-
vest their funds in loans to customers in their local market or deposit any sur-
plus funds at headquarters. Given this structure, member bank loan growth can
be financed through local deposits, through funds from headquarters via the
internal capital market, or through retained earnings.
362
For our analysis, we use a proprietary dataset with information on the group’s
entire internal capital allocations on a quarterly basis from January 2005 to
September 2007. The data come from the group’s internal managerial account-
ing system, and include all transactions between headquarters and the member
banks. Specifically, we are able to directly observe the funds that are trans-
ferred from headquarters to the banks or vice versa. Such data are typically
not available from public sources. Our data also contain information on loans,
deposits, and other important accounting figures on the member bank level.
Table 1 provides some primary information on the group’s internal capital
market. The table documents significant fund transfers within the group. Funds
Table 1
Summary Statistics on Internal Capital Market and Bank Characteristics
Cross-sect.
Variable Mean Median Panel STD STD 5% 95%
Funds from HQ (in EUR 1,000) 370,000 307,000 291,000 286,000 70,800 862,000
Funds from HQ/Total Assets 0.30 0.30 0.09 0.09 0.15 0.44
Deposits at HQ (in EUR 1,000) 126,000 107,000 87,300 83,500 32,600 283,000
Deposits at HQ/Total Assets 0.11 0.10 0.03 0.03 0.07 0.17
Net HQ Funds (in EUR 1,000) 245,000 188,000 245,000 240,000 −10,700 641,000
Net HQ Funds/Total Assets 0.19 0.20 0.11 0.11 −0.01 0.36
Net Provider of Funds 0.06
Net Receiver of Funds 0.94
Deposits/Total Assets 0.57 0.57 0.08 0.08 0.44 0.70
Deposit Growth (in %) 1.87 1.63 3.78 0.79 −2.36 6.79
Loans/Total Assets 0.80 0.81 0.04 0.04 0.73 0.85
Loan Growth (in %) 2.13 1.98 1.63 0.82 0.09 4.63
Business Loan Growth (in %) 1.59 1.37 2.58 1.08 −2.79 7.28
Personal Loan Growth (in %) 2.21 2.09 1.19 0.70 0.23 4.71
Business Loans/Total Assets 0.25 0.24 0.07 0.07 0.15 0.38
Private Loans/Total Assets 0.55 0.56 0.08 0.07 0.43 0.67
Bank Capital/Total Assets 0.05 0.05 0.02 0.02 0.03 0.08
Bank Capital Growth (in %) 1.40 0.00 3.87 0.85 −0.28 8.87
Bank Productivity 1.35 1.34 0.17 0.15 1.10 1.62
Solvency 1.40 1.43 0.25 0.24 1.01 1.77
Loan Loss Provisions/Total Assets (in %) 0.050 0.012 0.115 0.033 −0.080 0.259
ROE (in %) 8.65 8.78 2.55 1.79 4.45 12.25
ROA (in %) 0.406 0.386 0.203 0.108 0.126 0.773
Influence 1.18 1.10 0.40 0.40 0.65 1.92
Ownership Rights (in %) 0.54 0.49 0.29 0.29 0.18 1.10
Voting Rights 6.44 7.00 1.72 1.72 4.00 9.00
Estimate of “True Votes” 6.56 6.17 1.96 1.94 4.36 9.93
STD Deposit Growth (in %) 3.13 2.62 2.32 2.33 1.67 5.41
Average Loan Growth Region (in %) 1.87 1.57 1.93 0.30 −0.91 5.48
The table provides summary statistics describing the member banks and the internal capital market. It reports
both the panel (overall) as well as the cross-sectional (between) standard deviations. For definitions of the vari-
ables, see Appendix A-1. Correlations between the main variables are reported in Appendix A-2. The summary
statistics are based on quarterly data for Q1 2005 to Q3 2007. The total number of banks in the sample is 181. All
figures are reported on the member bank level. The total number of observations reported here is 1,991 unless a
variable is a “growth” variable, in which case the number of observations is 1,810 because Q1 2005 drops out in
calculations of quarter-to-quarter changes. Business Loan Growth and Personal Loan Growth are winsorized at
5%. Funds from HQ are the loans extended by headquarters to the member banks in the group. Deposits at HQ
are the funds deposited by member banks at headquarters. Net HQ Funds is the difference between loans from
headquarters and deposits at headquarters.
363
from headquarters constitute, on average, a substantial 30% of the total funding

of a member bank. At the same time, the average bank deposits 11% of its total
assets at headquarters. As a result, net funds from headquarters are equal to an
average of 19% of a bank’s total assets. In 94% of the bank quarters, banks are
net receivers of funds from headquarters.7 Therefore, member banks rely to a
significant extent on funding from headquarters to finance their local lending.
Not surprisingly, Table 1 also shows that the other main source of member bank
funding is deposits made by customers in the local market. Deposits constitute,
on average, about 57% of a bank’s total funding.
Given the group’s excellent external capital market access, lending on the
aggregate group level is largely unrelated to fluctuations in aggregate deposits.
This is evident in Figure 1, which presents the time series of the group’s ag-
gregate loan growth and deposit growth (obtained by aggregating bank-level
data). This suggests that headquarters is able to smooth out group-level fund-
ing shortages by tapping into the external capital market and providing those
funds to the member banks. As a result, any correlations between loan and de-
posit growth on the member bank level are likely to be the result of frictions in
the internal capital allocation process rather than the result of frictions between
headquarters and the external capital market. Frictions between headquarters
and the external capital market may be low because the group has a top credit
rating.
We study the functioning of the group’s internal capital market in more detail
in Section 2. In particular, we investigate whether the internal capital market
Figure 1
Time Series of Aggregate Loan and Deposit Growth on the Banking Group Level
This figure shows the time series of deposit and loan growth aggregated on the group level. Both variables are
calculated by aggregating the loans and deposits for all member banks. We observe that aggregate loan growth
is much more volatile than aggregate deposit growth on the group level.
7 Sixteen of the 181 individual banks are net payers into the system in at least one quarter. Of these, four are net
payers throughout the sample period (i.e., 11 quarters), three are net payers for 10 quarters, and the rest, on
average, are net payers for five quarters.
364
of the group is able to provide an intertemporal smoothing function to its mem-

ber banks.
1.3 Member Bank Influence

Motivated by the literature on “socialist” tendencies within internal capital
markets (e.g., Rajan, Servaes, and Zingales 2000; Shin and Stulz 1998), we
also examine how influence within the group is related to headquarters’ cap-
ital allocations and deposit smoothing. Our proxy for a member bank’s rela-
tive “influence” is a bank’s voting rights share in the headquarters divided by
its ownership rights share. Therefore, a member bank is considered more in-
fluential if it holds more voting rights relative to its ownership rights in the
headquarters.
The voting rights distribution is shown in Figure 2. With the total number
of votes in the headquarters equal to 1,165 and the maximum number of votes
held by a member bank equal to 10, even the largest bank holds less than
2% of the overall voting rights. Therefore, our influence proxy should not be
interpreted as reflecting overall dominance but more influence within the orga-
nization relative to a given ownership share.8
The group’s voting rights structure was shaped many decades ago, and nei-
ther voting rights nor ownership rights change in our sample. The allocation of
headquarters’ funds to the member banks was not an important consideration
Figure 2
Distribution of Voting Rights in the Banking Group
This figure shows the distribution of voting rights in the banking group. Voting rights are constant over time,
and vary across member banks between a minimum of 1 vote and a maximum of 10 votes. The figure shows, for
example, that 32% of the banks in the sample have seven votes. The group consists of 181 member banks.
8 The US Senate may provide an imperfect but still useful analogy to illustrate the idea behind our measure. With
only about 0.2% of the US population, the state of Alaska can elect two senators to the 100-member US Senate.
With a 2% vote share in the Senate, Alaska does not have dominant control. However, it may enjoy influence
disproportionate to its size because its support can be won over with a smaller favor than, for example, the favor
the much more populous California would be likely to require.
365
in the past because, until recently, most local banks had more deposits than
lending opportunities (i.e., internal transfers from headquarters to members
were generally not needed). Furthermore, many of the variations in the ratio
of voting rights to ownership rights are created by the discontinuous feature
of the voting rights system. Irrespective of the number of shares a bank owns,
the smallest member banks with the lowest numbers of shares have at least one
vote, while the largest member banks with the highest numbers of shares are
assigned, at most, ten votes. Moreover, as fractional votes are not possible, a
member bank whose ownership rights (a continuous variable) narrowly qualify
it for seven votes would control the same voting rights as another bank whose
larger number of shares would almost qualify it for eight votes. We explore
some of these discontinuities in our robustness checks.
Table 1 shows that the influence variable has an average value of 1.18 and
its standard deviation of 0.40 indicates significant cross-sectional variation.
Banks hold, on average, 6.4 voting rights (votes) in the headquarters and have
an ownership share of 0.54%. Figure 3 depicts the nonlinear relations between
a member bank’s size, voting rights, ownership rights, and influence within the
group. The figure illustrates that the number of ownership and voting rights
generally increases with bank size. Furthermore, it documents a correlation of
−53% between influence and size. However, it also shows that many of the
variations in the influence proxy are not explained by size. We show in our
subsequent analyses that our results are probably not driven by this correla-
tion. We do so by controlling for size, by removing the largest banks, and by
dividing banks into size-based subsamples.
Figure 3
Distribution of Influence in the Banking Group
The figure shows the relation between member bank size (measured as total assets of a bank) and the number of
voting rights (left axis), ownership rights (in percentages, right axis), and influence (right axis). Influence is the
share of voting rights of a member bank in headquarters divided by its share of ownership rights in headquarters.
The observations in the figure are based on bank asset values in Q3 2007.
366
1.4 Controlling for Investment Opportunities

Accounting for investment opportunities, which may differ across banks,
is a major challenge in the banking and internal capital market literature.
Changes in loan growth could be driven by unobserved differences in the
local economic circumstances faced by different banks. Moreover, changes
in local deposits may partially reflect changes in lending opportunities. Sev-
eral aspects of our empirical design allow us to mitigate these endogeneity
concerns: the homogeneity of member banks, the use of regional fixed ef-
fects that change each quarter, the ability to directly control for bank pro-
ductivity, and an event that provided an exogenous shock on the banks’
deposits.
First, the homogeneity of the member banks facilitates across-bank com-
parisons. All member banks operate under the same brand name with the
same business model, and they use identical products and pricing policies.
Each member bank operates only in its own local area. Some member banks
may be bigger, mostly because they happen to cover a larger local area and
therefore have more branch locations.
Second, the group’s overall market is highly homogeneous in terms of so-
cial and economic development. We try to control for any remaining varia-
tion in local market conditions by employing regional fixed effects that change
each quarter. As a result, we compare a member bank to the other member
banks (about one dozen on average) in its relatively small proximate region
in each time period. As we allow this local economic environment to change
each quarter, the effect of local market conditions on the loan and deposit
growth of banks in the region should be largely captured by these region-by-
quarter fixed effects. Our results are also robust to the inclusion of bank fixed
effects.
In addition, the supply of local deposits could be considered largely ex-
ogenous to the member banks because all member banks offer the same rates
for the same deposit products. This should be particularly the case in a de-
posit windfall event, which we explore later in this study. Deposit growth also
seems to be unrelated to bank effort, as we do not find any evidence that total
full-time working hours at a member bank—a proxy for effort—are correlated
with deposit growth. Therefore, the supply of local deposits and, in particular,
savings deposits seems to be mainly influenced by local economic and demo-
graphic conditions, competition with banks outside the group, and macroeco-
nomic factors. We try to control for these factors by using the aforementioned
region-by-quarter fixed effects.
Third, our dataset includes the banking group’s own internal measure
of bank productivity, defined as income over costs. This variable measures
how well a member bank turns input (costs) into output (income) in its
lending activities. The ability to control for current productivity differen-
ces further mitigates concerns about unobserved differences in investment
opportunities.
367
2. Empirical Results
2.1 The Functioning of the Internal Capital Market
Our empirical analysis starts with an exploration of the functioning of the
group’s internal capital market, particularly capital transfers from headquar-
ters to member banks. We measure internal capital allocations as net funds
from headquarters relative to member banks’ total assets.
In our first analysis, we regress the net funds from headquarters on bank
deposit growth to study how such transfers are related to the local funding po-
sitions of a bank. We control for member bank size, solvency, and productivity.
Bank Size is the log of total assets. Solvency, a measure of capital constraints,
is the ratio of actual capital to the regulatory capital required by banking super-
visors. Bank Productivity is included to control for investment opportunities on
the bank level. All regressions use region-by-time fixed effects to further con-
trol for variations in local market conditions. Standard errors are robust and
clustered at the member bank level.
The regression results are reported in Table 2. The regressions use ten quar-
ters of observations for 181 banks, as we lose one quarter of data (Q1 2005)
Table 2
Net Funding from Headquarters
Net HQ Funds/Total Assets Net Provider of Funds
(1) (2) (3) (4)
Deposit Growth −0.0026*** −0.0026*** 0.0017*
(3.93) (7.00) (1.79)
Transaction Account −0.0006***
Deposit Growth (8.17)
Term Deposit Growth −0.0000*
(1.90)
Savings Deposit Growth −0.0011***
(3.52)
Log(Total Assets) 0.0014 0.0981* 0.0742 −0.0833
(0.13) (1.69) (1.23) (0.74)
Solvency −0.2067*** −0.0906*** −0.0946*** 0.1494
(8.28) (3.65) (3.77) (1.07)
Bank Productivity 0.1966*** 0.0127 0.0117 0.0454
(5.46) (0.71) (0.61) (0.74)
Region-by-Time Fixed Effects YES YES YES YES
Bank Fixed Effects NO YES YES YES
Clustering by Bank YES YES YES YES
Observations 1810 1810 1810 1810
R-squared 0.537 0.426 0.376 0.099
This table examines the determinants of net funding from headquarters (inter-bank transfers). In columns 1–
3, the dependent variable is net funds from headquarters (defined as loans from headquarters minus deposits at
headquarters) divided by total assets of a member bank. We use deposit growth as the main independent variable.
In column 3, we decompose deposit growth into its three components: transaction account deposit growth, term
deposit growth, and savings deposit growth. In column 4, the dependent variable is a dummy variable that takes a
value of one if a bank is a net provider of funds in a given quarter. For definitions of the variables, see Appendix
A-1. The regressions use ten quarters of data (Q2 2005–Q3 2007) for 181 banks, as we lose one quarter of data
(Q1 2005) after including “growth” variables in the regressions. All standard errors are clustered at the member
bank level. Constants were included in the regressions but are not reported. Absolute values of robust t-statistics
are reported in parentheses. * denotes significant at 10%; ** significant at 5%; and *** significant at 1%.
368
after including any “growth” variables in the regressions. The results show
that member banks with lower local deposit growth receive more funding from
headquarters and that banks with higher local deposit growth receive less fund-
ing. This suggests that headquarters’ transfers respond to deposit growth on the
local bank level and that headquarters thereby provides an (at least partial) in-
tertemporal insurance function to its member banks. An important function of
the internal capital market, therefore, is that it allows headquarters’ funds to
augment deposit shortfalls on the local member bank level.
The effects of this deposit smoothing are economically large. Given the co-
efficient estimate in column 1, a one-standard-deviation decrease in deposit
growth is associated with an increase in net funding from headquarters of about
1% of total assets, which is equal to an increase in Net Funds from HQ/Total
Assets of more than 5% relative to the variable’s mean of 19%. Adding bank
fixed effects in column 2 does not change the coefficient on deposit growth,
although it lowers its standard deviation.
Funds from headquarters also respond to member banks’ productivity. Banks
that are more productive—which may mean that they have better investment
opportunities—generally receive more funding from headquarters. Based on
the coefficient estimate in column 1, a one-standard-deviation increase in bank
productivity is associated with an increase in capital allocation from headquar-
ters of about 3%. This is equal to an increase in net funding from headquarters
of more than 15% relative to the mean. We also find that larger banks generally
receive more funding from headquarters.
For the analysis in column 3, we separate deposit growth into its three com-
ponents: transaction account deposit growth, term deposit growth, and savings
deposit growth. Column 3 shows that funds from headquarters react mainly to
changes in savings deposit growth, which arguably constitutes the more ex-
ogenous, sluggish component of deposit growth. In column 4, we regress the
likelihood of a bank being a net payer into the internal capital market (i.e., a
net supplier of surplus funds to other banks) on bank characteristics, and find
that such banks generally have a higher deposit growth, which is consistent
with previous evidence.
We then analyze the extent to which the internal capital market and head-
quarters’ inter-bank transfers can insulate member bank investments from
changes in local deposit supplies. Following the banking literature, we measure
bank investments by looking at their net loan growth (see, e.g., Campello 2002
or Houston, James, and Marcus 1997). Net loan growth needs to be financed
either through local sources (i.e., new deposits, matured loans, or profits) or by
the headquarters through internal capital transfers.
We estimate the sensitivity of loan growth to local deposit growth in a re-
gression of loan growth on local deposit growth. Therefore, the coefficient of
deposit growth reflects how much a bank’s lending depends on local sources
of funding. We attempt to control for investment opportunities by including
region-quarter fixed effects, bank fixed effects, and bank productivity in our
369
Table 3
Sensitivity of Loan Growth to Deposit Growth
Loan Growth
(1) (2) (3) (4)
Deposit Growth 0.0661** 0.0438 0.0435
(2.15) (1.44) (1.40)
Transaction Account Deposit Growth 0.0042
(0.89)
Term Deposit Growth −0.0001
(0.63)
Savings Deposit Growth 0.1262**
(2.23)
Bank Capital Growth 0.0186 0.0157 0.0223 0.0157
(0.64) (0.51) (0.85) (0.50)
Log(Total Assets) −0.0538 3.7087* 4.3094** 3.7109*
(0.58) (1.68) (2.08) (1.68)
Solvency −1.6721*** −5.7433*** −5.5366*** −5.7432***
(5.68) (4.13) (4.28) (4.13)
Bank Productivity 1.9991*** 0.9157 0.9600 0.9145
(5.62) (1.07) (1.16) (1.07)
Loan Loss Provisions/Total Assets −0.1821 −0.6280 −0.5759 −0.6283
(0.34) (1.05) (1.00) (1.05)
Average Loan Growth Region 0.0072
(0.12)
Region-by-Time Fixed Effects YES YES YES YES

Bank Fixed Effects NO YES YES YES
Observations 1810 1810 1810 1810

R-squared 0.173 0.146 0.168 0.146
This table examines the determinants of loan growth (in percentages). We use deposit growth as the main inde-
pendent variables. In column 3, we decompose deposit growth into its three components: transaction account
deposit growth, term deposit growth, and savings deposit growth. Average loan growth region is the average
loan growth in a region computed for our sample of banks. For definitions of the variables, see Appendix A-1.
The regressions use ten quarters of data (Q2 2005–Q3 2007) for 181 banks, as we lose one quarter of data (Q1
2005) after including “growth” variables in the regressions. All standard errors are clustered at the bank level.
Constants were included in the regressions but are not reported. Absolute values of robust t-statistics are reported
in parentheses. * denotes significant at 10%; ** significant at 5%; and *** significant at 1%.
regressions. Additional controls are the log of total assets, growth in bank cap-
ital, the measure of capital constrains, and loan loss provisions over total assets.
The results, shown in Table 3, indicate that net loan growth is related to
locally generated funds (deposit growth). However, the coefficient for deposit
growth is quite small economically and becomes statistically insignificant when
bank fixed effects are included (column 2). As we show in Section 2.2, this
small average effect masks the significantly different outcomes for banks with
high and low influence.9
Column 3 decomposes deposit growth by product type: transaction account
deposit growth, term deposit growth, and savings deposit growth. Net loan
growth is sensitive mainly to changes in savings deposits. The results show that
9 The lack of a benchmark for the average loan to deposit growth sensitivity limits our economic interpretation of
the correlation. Instead, we focus on how sensitivity differs in more- or less-influential banks.
370
changes in transaction account deposits, compared with changes in savings ac-

count deposits, have only a negligible impact on loan growth. This mitigates
the concern that the correlation between loans and deposits arises naturally
because banks require borrowers to maintain a transaction account with the
banks for monitoring purposes (see Fama 1980, 1985). Finally, the regres-
sions show that more productive banks generally show higher loan growth,
and that our results are robust to controlling for average loan growth in a region
(column 4).
Overall, the banking group’s active internal capital market seems to largely
smooth out member banks’ local funding fluctuations. The limited dependence
of lending on the local deposit base is consistent with our previous finding that
transfers to and from headquarters play a deposit smoothing role.
2.2 Bank Influence and the Internal Capital Market

2.2.1 Bank Influence and Funding from Headquarters. We now analyze
how the headquarters’ intertemporal insurance function is related to the in-
fluence of member banks within the group. In particular, we wish to investi-
gate whether headquarters provides more deposit smoothing to more influential
banks. This analysis provides some insight into whether capital allocations are
related to internal corporate politics and sheds some light on the literature that
documents “socialist” tendencies in internal capital markets. To study how in-
fluence is related to the allocation of funds by headquarters, we augment the
regressions in Table 2 with the influence measure. As the influence variable
does not have time-series variation, the regressions do not include bank fixed
effects. The results are provided in Table 4.
We find that our influence proxy is significantly related to capital alloca-
tions: More influential banks receive more funds from headquarters. The ef-
fect of influence on internal capital allocation is economically large. Given
the coefficient estimate from column 1, a one-standard-deviation increase in
the influence variable is associated with an increase in the ratio of net funds
from headquarters to total assets of 0.40*0.143 = 6%. This is over 50% of the
cross-sectional standard deviation and about one-third of the median ratio of
net funds from headquarters to total assets.
To mitigate concerns that these results are driven by variations in ownership
or voting rights rather than by variations in the ratio of the two, column 2
controls for both ownership and voting rights. The estimates show that our
results are driven by the ratio of voting rights to ownership rights, rather than
by the individual components of the ratio.
Given the significant negative correlation between the influence proxy and
member bank size, we conduct a set of robustness checks to address the pos-
sibility that the influence results are mechanically driven by this correlation.
First, we remove all banks with ten votes (the maximum) in column 3 and
we remove the five largest banks from the sample in column 4. Second, we
371
Table 4
Bank Influence and Net Funding from Headquarters
Net
Provider
of
Net HQ Funds/Total Assets Funds
With
estimate
Without Without With of “true
All All banks five estimate votes” &
banks banks with 10 largest of “true hypoth. All
included included votes banks votes” influence banks
(1) (2) (3) (4) (5) (6) (7)
Deposit Growth −0.0029*** −0.0031*** −0.0032*** −0.0030*** −0.0029*** −0.0029*** 0.0016

(4.86) (5.03) (4.88) (4.75) (4.84) (4.90) (0.97)
Influence 0.1430*** 0.1529*** 0.1472*** 0.1439*** 0.1430*** 0.1338*** −0.1463**
(4.71) (4.27) (4.80) (4.66) (4.71) (4.92) (2.20)
Voting Rights −0.0222
(1.61)
Ownership Rights 2.1489
(0.52)
Estimate of 0.0006 −0.0033
“True Votes” (0.12) (0.39)
Hypothetical 0.0122
Influence (0.71)
Log(Total Assets) 0.0740*** 0.1305*** 0.0816*** 0.0754*** 0.0722*** 0.0895** −0.0717
(3.94) (3.34) (4.04) (3.78) (3.11) (2.17) (1.57)
Solvency −0.1497*** −0.1487*** −0.1503*** −0.1467*** −0.1494*** −0.1459*** 0.1447**
(6.47) (6.45) (6.46) (6.23) (6.37) (6.00) (2.06)
Bank Productivity 0.1252*** 0.1271*** 0.1159*** 0.1137*** 0.1253*** 0.1239*** −0.1204
(3.22) (3.32) (2.93) (2.85) (3.22) (3.14) (1.35)
Region-by-Time YES YES YES YES YES YES YES

Fixed Effects
Bank Fixed Effects NO NO NO NO NO NO NO
Clustering by Bank YES YES YES YES YES YES YES
Observations 1810 1810 1730 1760 1810 1810 1810

R-squared 0.625 0.631 0.639 0.626 0.625 0.626 0.231
This table examines the effects of influence on net funding from headquarters (inter-bank transfers). In columns
1–6, the dependent variable is net funds from headquarters (defined as loans from headquarters minus deposits
at headquarters) divided by the total assets of a member bank. Our main independent variable is the influence of
a bank inside the group. It is defined as the share of voting rights divided by the share of ownership rights of a
member bank in headquarters. Column 5 includes an estimate of the “true votes” of a bank, where we assume that
the actual votes are truncated at ten. We therefore estimate a first-stage Tobit model of actual votes on total assets
and include the predicated value as “Estimate of True Votes” in the regressions. Column 6 adds a hypothetical
influence measure, which is calculated in the same way as our influence proxy but uses the estimate of true votes
instead of actual votes in the calculation. In column 7, the dependent variable is a dummy variable that takes the
value of one if a bank is a net provider of funds in a given quarter. For definitions of the variables, see Appendix
A-1. The regressions use ten quarters (Q2 2005–Q3 2007) of data for 181 banks, as we lose one quarter of data
(Q1 2005) after including “growth” variables in the regressions. All standard errors are clustered at the member
bank level. Constants were included in the regressions but are not reported. Absolute values of robust t-statistics
are reported in parentheses. * denotes significant at 10%; ** significant at 5%; and *** significant at 1%.
estimate the “true” votes of a bank in a Tobit regression, in which we assume

that the number of “true” votes are a function of bank size and not limited
to ten. According to this hypothetical voting rights measure, the largest bank
would have 18 votes. We include the “true” vote measure as well as the actual
372
influence measure in the regressions (column 5). In column 6, we add a “hy-

pothetical” influence measure. We calculate this measure in the same way as
our normal influence measure but substitute the estimate of the “true votes” for
actual votes in the ratio numerator.
The results reported in Table 4 show that the effects of influence on capital
allocation are robust to these robustness checks—our influence proxy retains
its positive and significant coefficient. In addition, only the influence measure
based on actual votes matters. The hypothetical influence measure has no ef-
fect. The results in columns 5 and 6 do not change if we exclude bank size
from the regression (by construction, the log of total assets is highly correlated
with the estimate of “true votes”).
Finally, to address the possibility that bank size may have nonlinear impacts
and to mitigate the concern that our results are driven by the influence-size
correlation, we estimate regressions separately for subsamples of banks, which
are created on the basis of a bank size separation. To increase the robustness,
we also consider subsamples based on the banks’ voting rights and subsam-
ples based on ownership rights. The results are reported in Appendix A-3,
Panel A, and generally show robustness across subsamples. Overall, the ro-
bustness checks reduce the likelihood that the previous results are driven by the
correlation between size and influence. However, despite these checks, there is
still a possibility that some of the results are affected by this mechanical size
effect.
The results in column 7 of Table 4 complement the previous findings and
show that more-influential banks are less likely to be net providers of funds to
headquarters. Economically, a one-standard-deviation increase in influence is
associated with a 6% reduction in the probability of a bank being a net provider
of funds, which is about equal to the variable’s unconditional mean.
2.2.2 Bank Influence and the Loan Growth to Deposit Growth Sensitivity.
We also study the loan growth to deposit growth sensitivity of banks with high
and low influence by interacting deposit growth with the influence proxy. This
allows the loan-to-deposit sensitivity to vary across banks with high or low
levels of influence. As the interaction of deposit growth with influence cre-
ates time-series variation, these regressions can also employ bank fixed effects.
However, as the influence variable itself is absorbed by the bank fixed effects,
only the interaction terms enter the loan growth regressions.
The corresponding results are reported in Table 5. The negative and statis-
tically significant interaction term between deposit growth and the influence
measure provides evidence that the lending of more-influential member banks
is less sensitive to their own local cash flows. The interaction coefficient of
−0.157 in column 1 implies that for a member bank with relatively little in-
fluence (influence equal to 0.5), a one-standard-deviation decrease in deposit
growth is associated with a decrease in loan growth of 0.79%. This effect is
373
374
Table 5
Bank Influence and the Sensitivity of Loan Growth to Deposit Growth
Loan Growth
With
estimate
banks five estimate votes”
All All All All with 10 largest of “true hypoth.
banks banks banks banks votes banks votes” influence
(1) (2) (3) (4) (5) (6) (7) (8)
Deposit Growth 0.2860*** 0.2087*** 0.1939 0.1165 0.2152** 0.2119*** 0.3476*** 0.3344***
(4.16) (2.91) (1.23) (0.16) (2.57) (2.63) (3.36) (3.28)
Influence 0.0810 0.0960 −0.1456
(0.31) (0.37) (0.50)

Deposit Growth * Influence −0.1570*** −0.1174*** −0.1359* −0.1154*** −0.1203** −0.1182** −0.1640*** −0.1037**
(3.97) (2.83) (1.69) (2.85) (2.55) (2.58) (3.96) (2.29)
Deposit Growth * Voting Rights 0.0104
(0.62)
Deposit Growth * Ownership Rights −0.0638
(0.44)
Deposit Growth * Log(Total Assets) 0.0043
(0.13)
Deposit Growth * −0.0072 −0.0069
Estimate of “True Votes” (1.13) (1.13)
Deposit Growth * −0.0495**
Hypothetical Influence (2.43)
Estimate of “True Votes” 0.1556** 0.0953
(2.54) (1.12)
Hypothetical Influence 0.2869**
(2.01)
Bank Capital Growth 0.0562** 0.0484 0.0441 0.0470 0.0488 0.0474 0.0613** 0.0593**
(2.05) (1.55) (1.35) (1.42) (1.52) (1.50) (2.10) (2.06)
continued
Table 5
Continued
Loan Growth
With
estimate
banks five estimate votes”
All All All All with 10 largest of “true hypoth.
banks banks banks banks votes banks votes” influence
(1) (2) (3) (4) (5) (6) (7) (8)
Log(Total Assets) −0.1604 3.6151 3.4624 3.5791 3.3802 3.3770 −0.5617*** −0.2795
(1.20) (1.64) (1.55) (1.61) (1.42) (1.43) (3.12) (0.92)
Solvency −1.6895*** −5.6276*** −5.6656*** −5.6367*** −5.9619*** −5.9469*** −1.6091*** −1.5451***
(5.37) (4.25) (4.22) (4.22) (4.15) (4.13) (5.13) (4.86)
Bank Productivity 1.9447*** 0.8166 0.8322 0.8195 0.9311 0.9482 1.9502*** 1.9162***
(5.46) (0.97) (1.00) (0.98) (1.10) (1.13) (5.45) (5.32)
Loan Loss Provisions/Total Assets −0.1318 −0.5080 −0.5410 −0.5165 −0.5142 −0.4685 −0.2071 −0.3093
(0.26) (0.86) (0.92) (0.88) (0.85) (0.78) (0.42) (0.64)
Region-by-Time Fixed Effects YES YES YES YES YES YES YES YES
Bank Fixed Effects NO YES YES YES YES YES NO NO

Clustering by Bank YES YES YES YES YES YES YES YES
Observations 1810 1810 1810 1810 1730 1760 1810 1810
R-squared 0.195 0.160 0.161 0.160 0.161 0.159 0.201 0.206
This table examines the determinants of loan growth (in percentages). As explanatory variables, we use deposit growth, the influence measure, an interaction of deposit growth and the
influence variable, and a set of control variables. Our measure of influence is the share of voting rights divided by the share of ownership rights of a member bank in headquarters. In column
7, we include an estimate of the “true votes” of a bank and its interaction with deposit growth. We therefore assume that the actual votes are truncated at ten and estimate a first-stage
Tobit model of actual votes on total assets, and we include the predicated value as an estimate of “true votes” in the regressions. In column 8, we add a hypothetical influence measure that
is calculated in the same way as our influence proxy but uses the estimate of true votes instead of actual votes in the calculation. For definitions of the variables, see Appendix A-1. The
regressions use ten quarters of data (Q2 2005–Q3 2007) for 181 banks, as we lose one quarter of data (Q1 2005) after including any “growth” variables in the regressions. All standard
errors are clustered at the bank level. Constants were included in the regressions but are not reported. Absolute values of robust t-statistics are reported in parentheses. * denotes significant
at 10%; ** significant at 5%; and *** significant at 1%.
375
much more pronounced than in banks with influence equal to 1 (a decrease in

loan growth of 0.49%). For a relatively influential bank (influence value of 2),
a one-standard-deviation decrease in deposit growth is associated with a slight
increase in loan growth (0.11%). These results are robust when controlling for
bank fixed effects in column 2.
These findings suggest that not only do more-influential banks receive more
funding from headquarters, but their loan growth also shows a lower sensitivity
to deposit growth. Therefore, headquarters appears to provide more deposit
smoothing to more influential banks.
The negative coefficient for the interaction between deposit growth and in-
fluence is robust to the addition of interactions between deposit growth and
ownership rights, and to the addition of interactions between deposit growth
and voting rights (column 3). Therefore, the influence results are not driven by
variations in either ownership or voting rights, but rather by variations in the
ratio of the two.
Our results are also robust to the inclusion of an interaction term between
deposit growth and bank size (column 4), which suggests that size differences
do not drive the influence effect. Robustness checks on the influence-size rela-
tion, similar to those performed in Section 2.1 (excluding banks with ten votes;
including hypothetical influence measures), are reported in columns 5–8.10
2.2.3 Robustness Check: Regression Discontinuity Design. The divergence

between voting and ownership rights and, hence, the variation in influence (the
ratio of voting rights to ownership rights) arises from two sources: (1) banks
with similar numbers of ownership rights may be assigned different numbers
of voting rights because the number of voting rights can only be an integer
between one and ten; and (2) banks with the same number of voting rights can
have different numbers of ownership rights (number of shares). Our measure
of influence captures both sources of variations.
To provide some suggestive evidence on the relative exogeneity of our re-
sults, we undertake a test that explicitly exploits the first of these two discon-
tinuities. We sort banks into eight comparison groups based on their level of
ownership rights. Within each group, all banks have ownership rights within
25% of the group median but some banks have exactly one more vote than
others in the group, which is captured by a dummy variable (Plus One Vote
Dummy). Note that the test’s statistical power is weaker than when the in-
fluence measure is used directly, as the dummy variable exploits only some
discontinuity information.
10 The results are generally also robust across subsamples, as reported in Appendix A-3, Panel B. One exception is
the loan growth regressions with bank fixed effects in columns 7 and 8, where the coefficient on the interaction
between deposit growth and influence is significant only for the subsample of banks with above-median size (the
coefficient has a value of −0.14 with a t-statistic of 2.75). For the subsample of banks with below-median size,
this coefficient has a similar value of −0.13 but a much lower t-statistic of 1.47.
376
Although we control for possible differences in investment opportunities in

the discontinuity regressions, it is useful to examine whether investment oppor-
tunities differ for banks with one extra vote. To do so, we first estimate regres-
sions in which the dependent variables are various measures of investment op-
portunities (bank productivity, return on assets, and loan loss provisions rela-
tive to total assets), and the explanatory variables are the Plus One Vote Dummy
and a set of comparison group dummies. The regressions are reported in Ap-
pendix A-4 and show that banks with one extra vote have neither higher returns
on assets nor lower loan loss provisions. However, they do seem to be slightly
more productive. Second, we construct kernel density plots to compare the
distributions of our measures of investment opportunities between banks with
one extra vote and those without (Appendix A-5). The distributions are similar
for both groups of banks (as confirmed by Kolmogorov-Smirnov equality-of-
distributions tests), which is consistent with the regression estimates. Over-
all, these analyses suggest that, given observable bank characteristics, banks
on either side of the discontinuities have similar investment opportunities. To
account for any remaining differences, we control for the three investment
opportunity proxies individually in the discontinuity regressions.
The discontinuity regression results are reported in Table 6. They provide
suggestive evidence consistent with the main results. In terms of the net head-
quarters funding to total assets ratio, banks with “one more vote” are allocated
about 0.03 more resources from headquarters than their peers with similar own-
ership rights (column 1). The effect is economically significant because 0.03
represents an increase of more than 15% increase in the average HQ funding
ratio (which is about 0.19 across the sample). Moreover, the sensitivity of loan
growth to deposit growth is reduced from the unconditional sensitivity of 0.086
to (0.086-0.073) = 0.013, conditional on “one more vote” (column 5). While
this second effect is economically significant and comparable in size to our
main regression results, it is not statistically significant at conventional levels
( p-value of 0.22). As explained above, the statistical power of the discontinu-
ity regression model may be weaker, as it exploits only one source of variation
in the influence proxy.
Table 6 also reports robustness results in which we control for the interac-
tion terms between the “one more vote” dummy and the three measures of
investment opportunities. In these regressions, the sizes of the two key coef-
ficients remain similar to those reported in columns 1 and 5. However, the
estimation standard errors increase in some cases, which could be the result of
multicollinearity problems introduced by the newly added interaction terms.
One caveat to the above analysis is that it rests on the assumption that banks
on both sides of the discontinuity cutoff points are similar not only in terms
of observables but also in terms of unobservables. A further limitation of the
analysis is that the voting and cash flow rights structure (i.e., the discontinu-
ities) may have been endogenously chosen by the banking group and may not
be exogenous in that respect.
377
378
Table 6
Robustness Check for Effect of Influence: Discontinuity Regressions
Net HQ Funds/Total Assets Loan Growth
(1) (2) (3) (4) (5) (6) (7) (8)
Deposit Growth −0.0040*** −0.0040*** −0.0039*** −0.0038*** 0.0860 0.0848 0.0829 0.0892
(6.73) (6.87) (7.27) (7.28) (1.29) (1.27) (1.23) (1.29)
Plus One Vote Dummy 0.0299* 0.0877 0.0324 0.0469*** 0.0392 −0.4394 −0.1098 0.2671
(1.78) (1.03) (1.44) (2.68) (0.23) (0.46) (0.36) (1.40)
Plus One Vote Dummy * −0.0734 −0.0744 −0.0707 −0.0805
Deposit Growth (1.23) (1.25) (1.17) (1.34)
Log(Total Assets) 0.0784** 0.0770** 0.0878** 0.0877** 0.5290 0.5378 0.6411 0.6277
(2.12) (2.10) (2.23) (2.14) (1.19) (1.21) (1.40) (1.32)

Solvency −0.1638*** −0.1656*** −0.1638*** −0.1361*** −1.7036*** −1.6686*** −1.8411*** −1.4185***
(6.46) (6.64) (6.51) (5.30) (4.93) (4.92) (4.82) (4.13)
Bank Capital Growth 0.1145* 0.1154* 0.1155* 0.1579**
(1.70) (1.72) (1.67) (2.28)
Bank Productivity 0.1677*** 0.1925*** 1.7415*** 1.5304***
(4.30) (4.03) (4.09) (2.83)
Plus One Vote Dummy * −0.0429 0.3563
Bank Productivity (0.70) (0.52)
ROA 0.1043** 1.5700***
(2.55) (2.91)
Plus One Vote Dummy * ROA 0.0151 0.4777
(0.46) (0.95)
Loan Loss Provisions/Total Ass. 0.0169 −0.6655 −0.0637
(0.65) (1.17) (0.11)
Plus One Vote Dummy * −0.0566** −1.5659**
Loan Loss Prov./Total Ass. (2.18) (2.08)
continued
Table 6
Continued
(1) (2) (3) (4) (5) (6) (7) (8)
Region-by-Time Fixed Effects YES YES YES YES YES YES YES YES
Comparison Group Dummies YES YES YES YES YES YES YES YES
Comparison Group D. * Dep. Gr. NO NO NO NO YES YES YES YES
Clustering by Bank YES YES YES YES YES YES YES YES
Observations 1610 1610 1610 1610 1610 1610 1610 1610
R-squared 0.565 0.566 0.531 0.515 0.152 0.151 0.148 0.133
The dependent variable in columns 1–4 is net funds from headquarters (divided by total assets), while in columns 5–8 it is net loan growth (in percentages). The key explanatory variable
is a dummy variable (“Plus One Vote Dummy”) that captures some discontinuities in the relation between ownership and voting rights. Banks with “plus one vote” have similar ownership
rights in headquarters as other banks in their peer comparison groups, but they hold one extra vote. All banks hold ownership as well as voting rights in the headquarters, which we have used
to calculate a continuous measure of influence. As fractional voting rights are not allowed, banks with similar numbers of ownership rights (shares) may control different numbers of voting
rights (votes). We try to capture some of these discontinuities by creating a “Plus One Vote Dummy” variable using the following procedure: (1) we sort the banks on the basis of their voting
rights and then on the basis of their ownership rights; (2) within a group of banks with votes (N = [1,10]), those with below-median ownership rights are placed into comparison group N
and those with above-median ownership rights are placed into comparison group N +1; (3) within each comparison group, we sort banks by ownership rights; (4) we calculate the median
ownership rights within each comparison group; and (5) we drop those banks with numbers of ownership rights that deviate by more than 25% from the median in their comparison group.
As a result, within each comparison group, some banks have N votes while others have N-1 votes. A variable “Plus One Vote Dummy” is created for banks in the first group. Theoretically,
we should have nine comparison groups. However, all banks in comparison group 2 with one vote are dropped after step (5). In addition to the “Plus One Vote” dummy variable, the
regressions include a dummy variable for each comparison group. Implementing these procedures leaves us with 161 banks (in eight comparison groups) and quarterly observations from
Q2 2005 to Q3 2007. All standard errors are clustered at the member bank level. Constants were included in the regressions but are not reported. Absolute values of robust t-statistics are
reported in parentheses. * denotes significant at 10%; ** significant at 5%; and *** significant at 1%.
379
As a further extension, we look into the possibility of a voting coalition mo-

tivated by a regional divide. We study the effects of the influence of a coalition
of all banks in the north versus a coalition of all banks in the south.11 We cre-
ate an influence measure for the “north coalition” (“south coalition”), which
is the ratio of the voting rights share of all banks in the north (south) over the
ownership rights share of all banks in the north (south). The influence measure
value is 1.04 for the north and 0.98 for the south, which implies that the “north
coalition” would be more influential. We find that banks in the north receive
more funds from headquarters and that their loan growth is less related to their
deposit growth. The results are reported in Appendix A-6.
2.3 Influence and the Demand for Intertemporal Deposit Smoothing

If headquarters provides increased deposit smoothing to more-influential mem-
ber banks, we would expect our results to be strongest in cases where demand
for intertemporal smoothing is highest. Specifically, a higher demand for de-
posit smoothing may increase member banks’ incentives to exercise their in-
fluence over internal capital allocations. We investigate this by sorting member
banks into subsamples based on a measure for the demand for deposit smooth-
ing, and by dividing the loans of a given bank into those subject to high or low
demand for deposit smoothing. Table 7 reports the results of loan growth re-
gressions for subsamples of banks with different levels of demand for deposit
smoothing. Consistent with the previous evidence, we find that influence is
most important for the loan-to-deposit sensitivity for banks where the demand
for deposit smoothing is likely to be the greatest.
Our first proxy for the demand for deposit smoothing on the member banks
level is the standard deviation of deposit growth of a bank during the sam-
ple period. These results are reported in Panel A of Table 7. We use deposit
growth volatility as a proxy because more volatile deposits are associated with
greater fluctuations in funding gaps—the funding deficits or surpluses between
local investment opportunities and local deposits. Banks with greater deposit
growth volatility, therefore, experience larger funding deficits more frequently,
which implies a greater demand for headquarters transfers to smooth out lo-
cal deposits. We compare banks in subsamples with above- and below-median
standard deviations in deposit growth, as well as banks in the top and bottom
quartiles of the distribution.
In Panel A of Table 7, the coefficient on the interaction between deposit
growth and influence is insignificant for the sample of firms with a standard
11 Given the banking group’s history, a north-south divide may arise, as the banking group originally consisted of
two separate organizations with similar structures, one of which operated in the north, while the other operated
in the south. Member banks in the north or south may naturally form coalitions.
380
deviation of deposit growth below the median (column 1) or in the bottom

quartile (column 3). It is negative and strongly statistically significant for the
sample of firms where this proxy is above the median (column 2) or in the top
quartile (column 4). A Chow test shows that the interaction terms in columns
3 and 4 are statistically different from each other ( p-value = 0.02).12
Table 7
Bank Influence and Different Levels of Demand for Deposit Smoothing
Panel A: Deposit Growth Volatility
Loan Growth
(1) (2) (3) (4)
Deposit Growth Volatility
Low High Low High
(STD Deposit Growth (STD Deposit Growth (Q1 STD (Q4 STD
≤Median) >Median) Deposit Growth) Deposit Growth)
Deposit Growth 0.1922** 0.2776*** 0.1248 0.3906***
(2.44) (3.25) (1.33) (3.11)
Influence 0.1716 −0.4850 0.4606 0.8329
(0.52) (1.49) (0.74) (1.54)
Deposit Growth * −0.0878 −0.1467*** −0.0157 −0.2193***
Influence (1.51) (3.06) (0.21) (3.10)
Log(Total Assets) −0.0159 −0.3998*** 0.1819 −0.0454
(0.09) (2.74) (0.47) (0.20)
Solvency −1.1400*** −1.9025*** −0.7165 −1.3626**
(3.07) (4.23) (1.00) (2.17)
Bank Productivity 1.5019*** 2.1461*** 1.9087** 2.1673***
(3.33) (4.51) (2.33) (3.80)
Bank Capital Growth 0.1351** 0.0380 0.1144* 0.0685
(2.54) (1.22) (1.86) (1.64)
Loan Loss Provisions/ −0.1181 −0.0258 −1.9846* −0.2338
Total Assets (0.11) (0.04) (1.97) (0.12)
Region-by-Time Fixed YES YES YES YES
Effects
Bank Fixed Effects NO NO NO NO
Observations 900 910 450 460
R-squared 0.246 0.256 0.332 0.328
p -value of a Chow test (1) versus (2) (3) versus (4)
comparing coefficients p -value = 0.3991 p -value = 0.0201
on “Deposit Growth
* Influence” across
two regressions
Continued
12 As a robustness check, we use an alternative proxy for the demand for deposit smoothing. We assume that
banks operating close to a border with a neighboring country face additional competition from banks operating
in those countries, which may increase the demand for deposit smoothing. To test for the effects of influence,
we separate banks into those operating in regions bordering another country and those operating in regions not
bordering a neighboring country. The results are reported in Appendix A-7 and show that the coefficient of
deposit growth interacted with influence is about twice as small (−0.22 versus −0.12) for the sample of banks
in regions bordering neighboring countries. The interaction coefficient in column 1 is statistically different from
the one in column 2 at the 5% level.
381
Table 7
Continued
Panel B: Business and Personal Loan Growth
Business Loan Growth Personal Loan Growth
(1) (2) (3) (4)
Deposit Growth 0.1928*** 0.1861*** 0.1120*** 0.0516**
(3.30) (3.00) (4.64) (2.34)
Influence 0.1778 −0.0815
(0.52) (0.38)
Deposit Growth * −0.1098** −0.1170*** −0.0610*** −0.0270*
Influence (2.56) (2.67) (3.66) (1.88)
Bank Capital Growth 0.0521* 0.0822** 0.0184* 0.0046
(1.83) (2.41) (1.89) (0.41)
Log(Total Assets) −0.0144 1.9331 −0.1589 2.3697**
(0.07) (0.72) (1.21) (2.02)
Solvency −1.5667*** −4.9836*** −1.2501*** −2.1605***
(4.37) (3.58) (5.51) (3.27)
Bank Productivity 2.9270*** 2.9272* 1.4069*** 0.3086
(5.44) (1.88) (4.59) (0.64)
Loan Loss Provisions/ −0.2956 0.0944 −0.0649 −0.4378
Total Assets (0.39) (0.11) (0.19) (1.20)
Region-by-Time Fixed YES YES YES YES

Effects
Bank and Time Fixed NO YES NO YES
Effects
Observations 1810 1810 1810 1810

R-squared 0.195 0.168 0.208 0.178
p -value of a Chow test (1) versus (3) (2) versus (4)

comparing coefficients p -value = 0.3138 p -value = 0.0384
on “Deposit Growth
* Influence” across
two regressions
This table examines the effects of influence on the sensitivity of loan growth to deposit growth for banks with
different demands for deposit smoothing. Deposit smoothing demand is proxied by using the standard deviation
of deposit growth of a bank during the sample period. We use the standard deviation of deposit growth as a
measure of deposit smoothing demand, as more volatile deposit growth is associated with greater fluctuations in
the funding gaps (i.e., funding deficits or surpluses between investment opportunities and local deposit growth).
Banks with greater deposit growth volatility experience larger funding deficits more frequently. We separate the
sample into banks with low and banks with high levels of demand for deposit smoothing based on whether the
standard deviation of deposit growth is below or above the sample median (columns 1–2) and based on whether
a bank is in the bottom or top quartile of the variable’s distribution (columns 3–4). In Panel B, we separate loan
growth into business and personal loan growth, and we examine business and personal loan growth separately.
The latter type of loans is predominantly residential mortgage loans. We assume that the demand for deposit
smoothing is greater for business loans. For definitions of the variables, see Appendix A-1. The regressions use
ten quarters of data (Q2 2005–Q3 2007) for 181 banks. All standard errors are clustered at the member bank
level. Constants were included in the regressions but are not reported. Absolute values of robust t-statistics are
reported in parentheses. We also report p-values of Chow tests comparing the coefficients of the interaction term
“Deposit Growth * Influence” across regressions. * denotes significant at 10%; ** significant at 5%; and ***
significant at 1%.
In a second analysis, we decompose total loan growth into business loan

growth and personal loan growth. Personal loans, according to the banking
group’s definition, include mainly residential mortgage loans and consumer
loans, with the majority being residential mortgage loans. Business loans are
mainly made to small and medium-size enterprises, as large corporate loans
382
are made directly by headquarters. Business loans typically involve the pro-
duction of soft information (see, e.g., Liberti 2003; Stein 2002; Bharatha,
Dahiyab, Saunders, and Srinivasand 2007; and Liberti and Mian 2009), while
personal loans involve mostly hard information, as the banks commonly use
credit scores when making decisions on personal loans.
Both business loans and personal loans can be argued to have a greater need
for deposit smoothing. This is because the impact of influence on hard or soft
information can vary. On the one hand, if a bank fails to make a loan to a cus-
tomer because the bank is suffering from liquidity constraints (e.g., because
of a shock to local deposits), it may lose the customer and the banking rela-
tionship. This implies a forfeiture of future profits along with the bank’s past
investments in the relationship with the customer. As argued above, residential
mortgages are likely to be based largely on hard information with relatively
fewer investments in the bank’s relationship, so that a bank may lose little
in future rents when forgoing a lending opportunity. This may suggest that
there is a greater need for deposit smoothing in the business loan category.
Therefore, influence may matter more for business loans.
On the other hand, it may be easier for banks to utilize their influence when
referring to hard information if hard information travels better through a hier-
archy, and if it allows headquarters and local banks to bargain better. Liberti
and Mian (2009), for example, show that hierarchical distance between a sub-
ordinate and his boss makes it more difficult to share abstract and subjective
information in decision making. In that case, influence may matter more for
personal loans with hard information, in which case it should reduce the sen-
sitivity of loan growth to deposit growth more in the personal loan category.
Finally, greater influence may mean that the local managers are more “em-
powered.” Liberti (2003) shows that banking relationship managers who re-
ceive more authority rely more on soft information. In this case, influence
matters more for business loans and should therefore reduce the sensitivity
of loan growth to deposit growth more in the business loan category.
Overall, the question of which loan category influence is more relevant in
smoothing out changes in deposit growth is an empirical one. The results are
reported in Panel B of Table 7. Columns 1 and 2 use business loan growth as
the dependent variable, while columns 3 and 4 use personal loan growth as
the dependent variable. We find that influence is more important for business
loans in terms of reducing the sensitivity to deposit shocks, which may suggest
that there is a greater demand for deposit smoothing in the business loan cat-
egory. When personal loan growth is the dependent variable, influence has no
statistically significant effects. The coefficients of the interaction term between
columns 2 and 4 are significantly different at the 5% level.
To assess the economic significance of the differences across the business
and personal loan growth regressions, we perform a back-of-the-envelope cal-
culation based on coefficient estimates in columns 2 and 4. For a negative one-
standard-deviation shock to deposit growth (3.78%), an increase in the value
383
of influence by one reduces the impact of deposit growth on business loan

growth by (0.1170 * 3.78%) = 0.44 percentage points. A similar calculation
for personal loan growth implies a reduction of only (0.0270 * 3.78%) = 0.10
percentage points. The impact of influence on the deposit sensitivity of busi-
ness loan growth is, therefore, more than four times greater. As the average
growth rate of business loans during our sample period is smaller than per-
sonal loan growth (1.37% and 2.21%, respectively), the impact is even more
prominent in relative terms.
2.4 Windfall Deposits and Different Liquidity Conditions

We also study the role of influence in the presence of two events that create two
different shocks: (i) a group-wide windfall increase in deposits resulting from
a pending foreign takeover of a domestic competitor (a situation that leads to
improved internal funding); and (ii) a sudden deterioration in liquidity con-
ditions in the external capital markets resulting from a global financial crisis
(a situation where liquidity becomes more costly).
The first event acts as an exogenous and positive shock on the member
banks’ internal funding. As a result of a foreign takeover of a major rival, the
banking group experienced a large inflow of deposits in the second quarter of
2007. The inflow of deposits in that quarter is apparent from Figure 4. While
deposit growth rate increased by more than 250% relative to its normal level,
the loan growth rate increased by only about 15%.13
Figure 4
Comparison of Cash Windfall Quarter (Q2 2007) with All Other Quarters
This figure compares mean values of deposit growth, loan growth, and net funding from headquarters (Net HQ
Funds/Total Assets) between the cash windfall quarter of Q2 2007 and all other quarters of the sample period.
Deposit growth is significantly different at 1%. Loan growth is significantly different at 5%. Net HQ Funds/Total
Assets is not statistically different. In Q2 2007, the banks in the group experienced major deposit inflows as a
result of a foreign takeover of a major rival in the deposit market.
13 75% of the deposit inflows are from households (structurally, the bank depends more on household deposits), so
that it is unlikely that all of the windfalls are the result of business customers simultaneously moving both their
deposit and lending relationships to the banking group.
384
The substantial relaxing of member banks’ funding constraints in the sec-

ond quarter of 2007 implies less need for additional allocations of funds from
headquarters and less need for deposit smoothing. We therefore expect de-
posit windfalls to lower the importance of the internal capital market as an
insurance mechanism. The underlying assumption is that deposit windfalls
are exogenous to the characteristics of the local banks. We have some ev-
idence that this is indeed true in this case: The windfall deposits occurred
for basically all member banks of the group, and there is no evidence that
the abnormal deposit inflows are correlated with the influence measure, bank
size, or bank productivity. This is made clear in Appendix A-8, where we
regress two measures of the size of the cash windfall in Q2 2007 (deposit
growth and abnormal deposit growth in the quarter) on observable bank char-
acteristics. While these tests indicate no statistically significant relation
between the deposit windfalls and observable bank characteristics, the va-
lidity of our analysis still rests on the assumption that the windfalls are ex-
ogenous to both observables and unobservables (with the latter being
untestable).
While the deposit windfall event does not change the nominal distribution
of influence within the group, it may change the real effect of influence, as
influence seems less important in a situation where plenty of internal funds are
available and where deposit smoothing is not needed to the same extent. As a
result, we would expect the coefficient on a triple interaction of “influence,”
“deposit growth,” and the event dummy to be positive. In other words, the
coefficient on the double interaction term between “influence” and “deposit
growth” would be less negative (or closer to zero) during the event quarter
than in other periods.
Apart from providing us with an arguably exogenous reduction in the need
for deposit smoothing, we use this experiment to mitigate the concern that the
influence measure may act as a proxy for unobserved differences in bank pro-
ductivity or investment opportunities. It seems unlikely that any unobserved
productivity differences across member banks would change during the event
quarter. Furthermore, any change in investment opportunities is outweighed
by the positive shock to internal funding (the windfall deposits are about 15
times larger than the abnormal increase in lending volume). If the influence
measure is simply proxying for unobserved productivity, we would expect
its effects to remain the same during the quarter (i.e., it should not be dif-
ferent from all other quarters in the sample period). In this case, we would
expect the coefficient on the triple interaction to be zero (insignificant). In
other words, the coefficient on the double interaction term between influence
and deposit growth should be the same during the event as it is in other
periods.
Table 8, columns 1–3, shows the corresponding estimates. Column 1 con-
siders net funding from the headquarters, while columns 2 and 3 consider
loan growth. Columns 2 and 3 contain the triple interaction of “influence,”
385
386
Table 8
Liquidity Conditions, Deposit Smoothing, and Influence
Q2 2007 Dummy Only Q2 2007 and Q3 2007 Dummy TED Spread
Net HQ Funds/ Net HQ Funds/ Net HQ Funds/
Total Assets Loan Growth Total Assets Loan Growth Total Assets Loan Growth
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Deposit Growth −0.0029*** 0.3261*** 0.2536*** −0.0029*** 0.3339*** 0.2714*** −0.0029*** 0.3854** 0.3462**
(4.84) (4.11) (3.08) (4.86) (3.93) (3.11) (4.87) (2.40) (2.08)
TED Spread −0.0005* 0.0002 −0.0017
(1.84) (0.01) (0.06)
Q2 2007 Dummy * Influence * 0.3434** 0.2267* 0.3458** 0.2382*
Deposit Growth (2.36) (1.71) (2.37) (1.78)
Q3 2007 Dummy * Influence * −0.0133 0.1123

Deposit Growth (0.10) (0.68)
TED Spread * Influence * Deposit 0.0010 0.0026
Growth (0.27) (0.66)
Deposit Growth* Influence −0.1834*** −0.1431*** −0.1856*** −0.1525*** −0.1817** −0.1715*
(4.13) (3.09) (3.92) (3.12) (2.02) (1.85)
Q2 2007 Dummy * Influence 0.0081 −1.1674* −0.9400 0.0091 −1.0935* −0.8871
(1.48) (1.90) (1.50) (1.48) (1.77) (1.38)
Q3 2007 Dummy * Influence 0.0090 0.7835 0.4949
(1.31) (1.58) (1.01)
TED Spread * Influence 0.0002 0.0161 0.0126
(1.25) (1.26) (0.99)
Q2 2007 Dummy * Deposit −0.4117** −0.3640** −0.4201** −0.3856**
Growth (2.46) (2.32) (2.47) (2.41)
Q3 2007 Dummy * Deposit −0.0675 −0.2334
Growth (0.39) (1.10)
TED Spread * Deposit Growth −0.0050 −0.0071
(0.87) (1.18)
continued
Table 8
Continued
Q2 2007 Dummy Only Q2 2007 and Q3 2007 Dummy TED Spread
Net HQ Funds/ Net HQ Funds/ Net HQ Funds/
Total Assets Loan Growth Total Assets Loan Growth Total Assets Loan Growth
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Influence 0.1421*** 0.0915 0.1411*** 0.0216 0.1378*** −0.2589
(4.67) (0.35) (4.61) (0.08) (4.41) (0.66)
Bank Capital Growth 0.0613** 0.0514 0.0594** 0.0512 0.0536** 0.0468
(2.20) (1.63) (2.10) (1.62) (2.05) (1.55)
Log(Total Assets) 0.0740*** −0.1518 4.2479* 0.0739*** −0.1469 4.3964** 0.0740*** −0.1593 3.7905*
(3.93) (1.14) (1.89) (3.93) (1.10) (1.98) (3.93) (1.20) (1.76)
Solvency −0.1498*** −1.6815*** −5.4956*** −0.1498*** −1.6945*** −5.4280*** −0.1498*** −1.7175*** −5.5396***
(6.46) (5.39) (4.26) (6.46) (5.45) (4.22) (6.46) (5.46) (4.31)
Bank Productivity 0.1254*** 1.9283*** 0.8287 0.1258*** 1.9422*** 0.9973 0.1256*** 1.9651*** 0.9902
(3.22) (5.40) (0.98) (3.22) (5.40) (1.18) (3.22) (5.49) (1.20)
Loan Loss Provisions/Total Assets −0.1130 −0.5042 −0.1626 −0.5305 −0.2128 −0.5710
(0.22) (0.85) (0.32) (0.90) (0.42) (0.97)
Region-by-Time Fixed Effects YES YES YES YES YES YES YES YES YES
Bank Fixed Effects NO NO YES NO NO YES NO NO YES

Clustering by Bank YES YES YES YES YES YES YES YES YES
Observations 1810 1810 1810 1810 1810 1810 1810 1810 1810
R-squared 0.625 0.201 0.167 0.626 0.204 0.171 0.625 0.202 0.168
This table examines the effects of influence on the sensitivity of loan growth to deposit growth at times with different liquidity conditions. The regressions in columns 1–3 include a dummy
that takes the value of one if an observation is from Q2 2007. As a result of a foreign takeover of a major rival, the banking group observed a large inflow of deposits in this quarter, which
significantly reduced the demand for deposit smoothing by headquarters. Deposit growth in this quarter is more than three times its normal level. The regressions in columns 4–6 include
a dummy that takes the value of one if an observation is from Q3 2007. As a result of the global turmoil in financial markets, liquidity in interbank markets was costly in this quarter. The
regressions in columns 7–9 explicitly account for the cost of liquidity by including the TED spread (quarterly averages) during the sample period. The TED spread is the difference between
the three-month EURIBOR rate and the three-month Bund rate. The event dummies are captured by the region-by-time fixed effects. For definitions of the variables, see Appendix A-1. The
regressions use ten quarters (Q2 2005–Q3 2007) of data for 181 banks. All standard errors are clustered at the member bank level. Constants were included in the regressions but are not
reported. Absolute values of robust t-statistics are reported in parentheses. * denotes significant at 10%; ** significant at 5%; and *** significant at 1%.
387
“deposit growth,” and the event dummy. The coefficient on this triple interac-
tion term is significantly positive and economically meaningful. This suggests
that the effect of influence on the loan-to-deposit-growth sensitivity is signifi-
cantly smaller during the event quarter, which indicates that influence matters
less for deposit smoothing given a large exogenous windfall of cash inflow.
As argued, this finding also mitigates the concern that the influence measure
simply proxies for unobserved productivity, which is not expected to change
systematically during the quarter. This result is robust to the addition of bank
fixed effects in column 3.
For the second event, we look at the functioning of the group’s internal
capital markets during a period in which liquidity from external capital mar-
kets suddenly becomes much more costly. As a result of the start of the re-
cent global financial turmoil, liquidity conditions in financial markets were
substantially different in the third quarter of 2007 (the end of the sample pe-
riod) from those during the other quarters of the sample period. This can
be seen in Figure 5, which plots the TED spread over the sample period.
The TED spread is calculated as the difference between the three-month
EURIBOR and the three-month Bund rate. As it measures the difference
between the costs of inter-bank funding and government funding, the TED
spread can be used as a proxy for the cost of liquidity in financial markets.
As the cost of liquidity spiked in Q3 2007, we include a Q3 2007 dummy
in addition to the Q2 2007 dummy in a second set of regressions. In
addition, the dummy variables are interacted with influence and deposit
growth.
Figure 5
TED Spread during Sample Period
The figure plots the TED spread during the sample period. The TED spread is calculated as the difference
between the three-month EURIBOR and the three-month Bund rate (averaged over the respective quarters). As
a measurement of the difference of the cost of inter-bank funding versus government funding, the TED spread
can be used as a proxy for the cost of liquidity in financial markets.
388
The estimates are reported in columns 4–6 of Table 8. The estimates in col-
umn 4 do not suggest that more-influential banks received more funding in Q3
2007 than in other quarters. Moreover, influence does not appear to have been
more (or less) important in reducing the sensitivity of loan-to-deposit growth
in this quarter than in all other quarters (see columns 5–6). To undertake a ro-
bustness check of the previous results, we also include the TED spread as a
direct measure of the cost of liquidity in the regressions. These regressions—
which also suggest no effect of influence—are reported in columns 7–9 of
Table 8.
One reason that no effect is evident could be that the liquidity crisis did
not hit the banking group too severely because of its top credit rating and that
it benefited from the “flight to quality” seen in financial markets during the
crisis. In that case, influence would not be more important in this quarter than
in other quarters. An alternative reason could be that these tests do not have
enough statistical power to detect an effect.
3. Discussion of Results
Our article shows that the banking group’s internal capital market can take
on an intertemporal insurance function for its member banks by compensat-
ing for their deposit shortfalls. We also find that more funds are provided to
banks with better investment opportunities. These findings on the benefits of
internal capital allocations are related to existing literature on internal capital
markets.
Campello (2002) examines the functioning of internal capital markets
in US bank holding companies. He finds that small banks are insulated
from negative shocks to external financing if they are affiliated with large,
unconstrained banking groups, while independent, small banks are not in-
sulated. His findings are consistent with our observation that internal cap-
ital markets can provide insurance against negative financing cash flow
shocks.
Closely related to our work is the work of Gopalan, Nanda, and Seru (2007),
who study the internal capital markets in Indian business groups. As in our
banking group, Indian business groups use internal loans to allocate capi-
tal internally, typically at zero (and therefore subsidized) interest rates.
In terms of the actual flows between member firms, Gopalan, Nanda, and
Seru (2007) find that the groups’ internal capital markets help member firms
that are experiencing financial difficulties because of negative earnings
shocks.
In another study focusing on negative cash flow shocks, Lamont (1997) an-
alyzes how internal capital markets reacted after oil firms with significant non-
oil segments faced a negative cash flow shock arising from the sharp decline
in oil price in 1986. He finds that contractions in investments are also evident
in the non-oil segments of the oil firms, which he interprets as suggesting that
389
diversified companies tend to cross-subsidize and support poorly performing

segments.
In our study, we find evidence that banks with better investment opportuni-
ties receive more funds, which is in line with Maksimovic and Phillips (2002)
and Khanna and Tice (2001). In their examination of manufacturing firms,
Maksimovic and Phillips (2002) show that divisions with high productivity and
firms in industries with strong demand are allocated more capital through inter-
nal capital markets. Khanna and Tice (2001) study discount stores’ responses
to the entry of Wal-Mart, a more efficient competitor, into their markets. They
find that, compared to focused firms that operate only in the discount business,
discount divisions of diversified firms react more to changes in the productivity
of their discount stores by shutting down or reducing capital expenditures in
less productive stores.
While our article documents some bright sides of internal capital markets,
it should be noted that reallocations of capital across units may have some
dark sides as well. We find that greater influence is related to more capital
allocations from headquarters, and we cannot rule out the possibility that such
allocations may be inefficient in some ways.
Internal capital markets may lead to transfers of resources from divisions
with good investment opportunities to units with poor ones. This form of
corporate “socialism” has been documented in Rajan, Servaes, and Zingales
(2000), and seems particularly pronounced in firms with diverse resources
and opportunities. Moreover, firms with more cross-subsidization seem to
trade with a greater diversification discount, which suggests that “socialism”
in internal transfers can have real value effects. Rajan, Servaes, and Zingales
(2000) argue that the “socialist” distortions in capital allocations are
rooted in power struggles inside firms. In addition, Scharfstein and Stein
(2000), Wulf (1999), and Meyer, Milgrom, and Roberts (1992) argue that
agency conflicts inside the firm may lead to “socialist” and inefficient
allocations.
More recently, Duchin and Sosyura (2010) find that managers with social
ties to their CEOs receive more funds from headquarters, and that connections
may lead to less-efficient investments when governance is weak and more-
efficient investments when information asymmetry is high. Glaser, Lopez-de-
Silanes, and Sautner (2010) show that power is useful for obtaining large
allocations of capital in ad hoc situations—cash windfalls, in their case. In-
ternal capital markets may also harm the creation of new ideas inside firms
and lower employee creativity. Seru (2010) finds that firms with more active
internal capital markets produce fewer innovations and less novel research.
In a related study, Liberti (2003) provides detailed evidence from a bank sug-
gesting that loan officers perform better if they have more decision
authority.
Overall, although our findings highlight some aspects of fund allocations in
internal capital markets, our study does not account for other aspects, such as
390
the efficiency of these capital allocations and the consequences of such alloca-
tions for the incentives of local bank managers. We focus only on those aspects
of the broader research question that our data allow us to analyze in detail. It
is, therefore, difficult to provide a final assessment of the overall efficiency of
the banking group’s internal capital markets in terms of all of the positive and
negative effects of its internal capital transfers.
While several organizational features are specific to our banking group, our
findings may have implications that go beyond this organization. First, the
group’s structure is not uncommon. All 27 countries in the European Union, for
example, have banking groups with similar organizational structures in which
the headquarters is owned by local banks. At the end of 2006, these groups had,
in total, more than 4,000 member banks operating around 60,000 branches and
handling about 140 million customers. They had total assets of more than EUR
4.6 trillion and a 20% share of the deposit market. Second, most large com-
mercial banks structure their business organizations in broadly similar ways.
Specifically, many large banks seem to share the following features: (1) divi-
sions/branches are set up based on geographic areas; (2) branch managers have
a high level of autonomy in terms of making loans and accepting deposits in
local markets, but pricing is uniform across branches; (3) in developed coun-
tries, banks typically make more loans than the amount of deposits they collect
locally, which makes it necessary for branches to ask headquarters for extra
funding; and (4) some branch managers may have more influence than others
because of reputation, seniority, or connections.
4. Conclusion
This article studies the internal capital market of a large retail banking group
using proprietary data obtained from the group’s internal management ac-
counting system. The group consists of 181 member banks that operate in
different local markets and jointly own a headquarters organization.
We find an active internal capital market inside the group. Transfers from
headquarters partly compensate member banks for lower deposit growth,
thereby reducing the sensitivity of loan growth to deposit growth. This suggests
that the headquarters provides an intertemporal insurance function against fund-
ing shortfalls among its member banks. We also show that capital allocations
are larger for more productive banks with better opportunities. Furthermore,
we find that more influential banks receive more funds from headquarters. We
measure influence inside the organization in terms of the divergence from one
share–one vote using data on the voting and ownership rights of the member
banks in the headquarters organization. The loan growth of more-influential
banks is less sensitive to their own deposit growth, suggesting that more-
influential banks enjoy more deposit smoothing from headquarters. Finally, we
show that influence is less important when the demand for deposit smoothing
may be lower.
391
Appendices
Appendix A-1
Definition of Variables
Variable Definition
Total Assets Total assets of a bank in t (in EUR 1,000)
Deposits Total deposits taken by a bank in t from customers (in EUR 1,000) and
the sum of current account deposits, term deposits, and savings deposits
Loans Total outstanding loans provided by a bank in t (in EUR 1,000)
Loan Growth Growth in loans in t measured as log of loans in t minus log of loans in
t-1 and multiplied by 100
Business Loan Growth Growth in loans to business customers in period t measured as log of
loans in t minus log of loans in t-1 and multiplied by 100
Personal Loan Growth Growth in loans to private customers (mainly residential mortgage loans
and consumer loans) in period t measured as log of loans in t minus log
of loans in t-1 and multiplied by 100
Funds from HQ Funds/loans extended by headquarters to a bank in t (in EUR 1,000)
Deposits at HQ Money deposited at headquarters by a bank in t (in EUR 1,000)
STD Deposit Growth Standard deviation in deposit growth of a bank (measured over the sample
period)
Net HQ Funds Difference between Funds from HQ and Deposits at HQ, and a measure
of the net amount of funds extended by headquarters to a bank in t (in
EUR 1,000)
Net Provider of Funds Dummy variable that takes the value 1 if a bank is a net provider of funds
(i.e., Net Funds from HQ<0) in t
Net Receiver of Funds Dummy variable that takes the value 1 if a bank is a net receiver of funds
(i.e., Net Funds from HQ≥0) in t
Bank Capital Equity of a bank in t (in EUR 1,000)
Bank Productivity Ratio of total income to total costs in t
Solvency Actual capital of a local bank divided by the capital required for banking
supervision purposes in t
Loan Loss Provisions Loan loss provisions in t (in EUR 1,000)
ROE Return on equity in t, measured as net income over equity (in %)
ROA Return on assets in t, defined as net operating income over total assets
(in %)
Influence Measures the influence of a bank in the organization and defined as the
ratio of a bank’s share of voting rights divided by its share of ownership
rights in headquarters; a member bank with more voting rights relative to
its ownership rights is perceived as more influential because it can bargain
for more favors relative to its ownership share
Voting Rights Measures the number of votes in headquarters held by a member bank;
ranges between 1 and 10
Ownership Rights Measures the number of shares held by a bank in headquarters divided by
the total number of shares outstanding (number reported in %)
Estimate of “True Votes” Hypothetical estimate of the “true votes” of a bank; we assume that the
actual votes of a bank are truncated at ten, and we estimate a Tobit model
of actual votes on total assets and region dummies; the predicated value
from this model is considered to be a hypothetical estimate of the “true
votes” of a bank
Hypothetical Influence Hypothetical influence measure, where the estimate of a bank’s “true
votes” is used to calculate the ratio of a bank’s share of hypothetical vot-
ing rights to its share of ownership rights in headquarters
Average Loan Growth Region Average loan growth in a region computed for the sample of banks
392
Appendix A-2
Correlations of Main Variable
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)
Deposit Growth (in %) (1) 1.00
Loan Growth (in %) (2) 0.18 1.00
Business Loan Growth (in %) (3) 0.08 0.65 1.00
Personal Loan Growth (in %) (4) 0.15 0.63 0.06 1.00
Bank Capital Growth (in %) (5) 0.08 0.08 0.07 0.01 1.00
Bank Productivity (6) 0.08 0.17 0.17 0.17 0.06 1.00
Solvency (7) −0.07 −0.20 −0.09 −0.21 0.00 0.05 1.00
ROE (in %) (8) 0.11 0.19 0.18 0.13 0.09 0.75 0.18 1.00
ROA (in %) (9) −0.11 0.04 0.05 0.03 0.05 0.54 0.25 0.55 1.00
Influence (10) 0.03 0.05 0.02 0.06 −0.01 0.12 −0.09 0.00 −0.03 1.00
Ownership Rights (in %) (11) −0.03 −0.02 0.01 −0.03 0.00 −0.05 −0.04 0.01 0.02 −0.84 1.00
Voting Rights (12) 0.02 0.05 0.04 0.06 0.01 0.12 −0.31 0.08 −0.01 −0.61 0.80 1.00
STD Deposit Growth (in %) (13) 0.05 0.08 0.08 0.06 −0.10 −0.02 −0.37 −0.09 −0.13 0.17 −0.04 0.13 1.00
Net HQ Funds/Total Assets (14) −0.05 0.11 0.11 0.07 0.00 0.29 −0.49 0.01 −0.05 0.25 −0.11 0.20 0.33 1.00
This table provides correlations of the main variables in our dataset.
393
394
Appendix A-3
Robustness Checks: Separation of Sample Based on Size, Ownership Rights, and Voting Rights
Panel A
Dependent Variable: Net HQ Funds/Total Assets
(1) (2) (3) (4) (5) (6)
Bank Size (Total Assets) Ownership Rights Voting Rights
< median ≥ median < median ≥ median < median ≥ median
Deposit Growth −0.0036*** −0.0026*** −0.0034*** −0.0030*** −0.0038*** −0.0025***
(3.71) (3.87) (4.17) (5.22) (3.93) (4.21)
Influence 0.1313*** 0.1989** 0.1285*** 0.1784*** 0.1258*** 0.2025***

(6.37) (2.30) (5.08) (2.96) (5.69) (2.77)
Log(Total Assets) 0.0546*** 0.0648 0.0813*** 0.0664** 0.0415*** 0.0718
(4.05) (1.41) (4.21) (2.63) (2.99) (1.62)
Solvency −0.1293*** −0.1333** −0.1694*** −0.1239*** −0.1148*** −0.1452***
(4.94) (2.21) (5.56) (3.07) (4.23) (2.75)
Bank Productivity 0.1465*** 0.0849 0.1674*** 0.0640 0.1371*** 0.0980
(3.24) (1.26) (3.98) (1.12) (2.78) (1.54)
Region-by-Time Fixed Effects YES YES YES YES YES YES
Bank Fixed Effects NO NO NO NO NO NO
Clustering by Bank YES YES YES YES YES YES
Observations 900 910 900 910 840 970
R-squared 0.668 0.511 0.565 0.593 0.656 0.536
continued
Appendix A-3
Continued
Panel B
Dependent Variable: Net Loan Growth
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
Bank Size (Total Assets) Ownership Rights Voting Rights Bank Size (Total Assets) Ownership Rights Voting Rights
< median ≥ median < median ≥ median < median ≥ median < median ≥ median < median ≥ median < median ≥ median
Deposit Growth 0.3252*** 0.3071*** 0.2764** 0.2514*** 0.3626*** 0.2946*** 0.1958 0.2647** 0.2250* 0.1729* 0.2165 0.2566***
(2.64) (3.15) (2.32) (2.75) (2.83) (3.20) (1.47) (2.63) (1.90) (1.87) (1.52) (2.64)
Influence 0.1601 −0.2410 −0.2033 0.1637 0.1822 −0.0428
(0.40) (0.69) (0.58) (0.64) (0.45) (0.13)
Deposit Growth* −0.1890** −0.1681*** −0.1006 −0.1561*** −0.2005** −0.1671*** −0.1291 −0.1412*** −0.0808 −0.1129* −0.1337 −0.1438***
Influence (2.32) (3.23) (1.26) (2.76) (2.40) (3.34) (1.47) (2.75) (1.02) (1.93) (1.46) (2.81)
Bank Capital Growth 0.0294 0.0602* 0.2134** 0.0271 0.0193 0.0672* 0.0085 0.0498 0.2251** 0.0184 −0.0085 0.0579
(0.56) (1.70) (2.45) (1.62) (0.35) (1.88) (0.15) (1.30) (2.26) (0.81) (0.14) (1.47)
Log(Total Assets) −0.2985 0.3752 −0.4186** 0.0451 −0.3161* 0.3797 6.6232* −0.2829 2.2693 4.2847 7.2532** −0.2873
(1.56) (1.37) (2.21) (0.23) (1.73) (1.40) (1.95) (0.11) (0.74) (1.24) (2.00) (0.12)
Solvency −1.6486*** −1.7998*** −0.8656* −2.1847*** −1.5925*** −1.7622*** −4.7219*** −5.2665** −6.0757*** −5.3948*** −4.9119*** −5.0996**
(3.54) (4.36) (1.92) (5.68) (3.26) (4.34) (2.66) (2.45) (3.04) (2.82) (2.66) (2.43)
Bank Productivity 2.3610*** 1.9372*** 1.6486*** 2.1930*** 2.1841*** 2.0055*** 1.5223 0.3298 0.3968 0.8989 0.9349 0.6272
(4.10) (4.71) (2.94) (4.75) (3.66) (4.75) (1.43) (0.26) (0.33) (0.87) (0.77) (0.51)
Loan Loss Provisions/ 0.2617 −1.1502* 0.1930 −0.6245 0.0069 −0.8756 0.0603 −1.1229 0.4828 −1.8395* −0.2684 −0.8276
Total Assets (0.33) (1.86) (0.27) (0.62) (0.01) (1.63) (0.06) (1.63) (0.55) (1.82) (0.25) (1.45)
Region-by-Time YES YES YES YES YES YES YES YES YES YES YES YES
Fixed Effects
Bank Fixed Effects NO NO NO NO NO NO YES YES YES YES YES YES
Clustering by Bank YES YES YES YES YES YES YES YES YES YES YES YES
Observations 900 910 900 910 840 970 900 910 900 910 840 970
R-squared 0.103 0.190 0.121 0.204 0.108 0.185 0.096 0.124 0.159 0.084 0.109 0.122
This table complements Table 4 and 5 in the article. It decomposes the sample based on bank size (total assets), ownership rights, and voting rights into two groups. In Panel A, the dependent
variable is net funds from headquarters divided by total assets of a bank. In Panel B, the dependent variable is loan growth (in %). Our measure of influence is the disproportionate influence
of a member bank in the group. It is defined as the share of voting rights divided by the share of ownership rights of a member bank in headquarters. For definitions of the variables, see
Appendix A-1. The regressions use ten quarters of data (Q2 2005–Q3 2007) for 181 banks, as we lose one quarter of data (Q1 2005) after including any “growth” variables in the regressions.
All standard errors are clustered at the bank level. Constants were included in the regressions but are not reported. Absolute values of robust t -statistics are reported in parentheses. * denotes
395
significant at 10%; ** significant at 5%; and *** significant at 1%.
Appendix A-4
Investment Opportunities around Discontinuities
Loan Loss Provisions/
Bank Productivity ROA Total Assets
(1) (2) (3)
Plus One Vote Dummy 0.0810*** 0.0191 0.0042
(3.02) (0.92) (0.60)
Comparison Group 1 0.0706 0.0312 0.0331
(0.53) (0.28) (1.31)
Comparison Group 2 −0.0276 0.0089 0.0006
(0.63) (0.21) (0.05)
Comparison Group 3 −0.0058 0.0519 −0.0145
(0.12) (1.13) (1.24)
Comparison Group 4 0.0779* 0.0961** −0.0032
(1.66) (2.19) (0.33)
Comparison Group 5 0.0386 0.0413 −0.0018
(0.87) (1.00) (0.24)
Comparison Group 6 0.0803* 0.0760* −0.0001
(1.88) (1.85) (0.02)
Comparison Group 7 0.0539 0.0650 −0.0026
(1.08) (1.38) (0.31)
Constant 1.3613*** 0.3725*** −0.0013
(19.93) (7.61) (0.09)
Region-by-Time Fixed Effects YES YES YES
Clustering by Bank YES YES YES
Observations 1610 1610 1610
Adj. R-squared 0.198 0.575 0.576
This table examines three measures of investment opportunities across the discontinuity cutoffs: bank produc-
tivity, return on assets, and loan loss provisions over total assets. The main independent variable is the Plus One
Vote Dummy, which measures the discontinuities in the relation between voting rights and ownership rights. The
variable takes the value of one if a bank has one extra vote compared to a group of banks with similar ownership
rights in headquarters. The aim is to test whether banks around the discontinuity are similar with regard to their
investment opportunities. The regressions use quarterly data from Q1 2005 to Q3 2007. All standard errors are
clustered at the member bank level. Absolute values of robust t -statistics are reported in parentheses. * denotes
significant at 10%; ** significant at 5%; and *** significant at 1%.
396
Appendix A-5
Kernel Density Plots
These figures provide kernel density plots for three measures of investment opportunities: bank productivity,
return on assets, and loan loss provisions over total assets. The plots report the distributions for banks with (solid
line) and without (dashed line) one extra vote. p -values of Kolmogorov-Smirnov Equality-of-Distributions Tests
are reported below the figures.
397
Appendix A-6
Voting Block Analysis
(1) (2)
Deposit Growth −0.0031*** 0.1342***
(4.89) (3.72)
North 0.0709*** 0.0557
(5.60) (0.42)
North * Deposit Growth −0.1308***
(3.20)
Log(Total Assets) 0.0028 −0.0426
(0.27) (0.44)
Solvency −0.2113*** −1.4115***
(7.71) (5.49)
Bank Productivity 0.1932*** 1.6281***
(5.66) (4.78)
Bank Capital Growth 0.0340**
(2.30)
Loan Loss Provisions/Total Assets −0.2222
(0.55)
Region-by-Time Fixed Effects NO NO
Clustering by Bank YES YES
Observations 1810 1810
R-squared 0.430 0.122
This table examines the effects of north and south coalitions of banks on net funding from headquarters (col-
umn 1) and the sensitivity of loan growth to deposit growth (column 2). A north-south divide may arise, as the
group historically (until the early 1970s) consisted of two separate organizations with similar structures, one of
which operated in the north and one of which operated in the south of the same country. Member banks in the
north or south may form coalitions. We therefore create an influence measure for the “north coalition” (“south
coalition”), which is the ratio of the voting rights share of all banks in the north (south) over the ownership
rights share of all banks in the north (south). The influence measure value is 1.04 for the north and 0.98 for the
south. Based on this measure, the north coalition would be considered more influential inside the group. We
therefore include the “North” dummy in the HQ fund regression and a “North * Deposit Growth” interaction
term in the loan growth regression. This allows us to test whether banks in the north show a different behavior
than those in the south. The regressions use ten quarters of data (Q2 2005–Q3 2007) for 181 banks. All standard
errors are clustered at the bank level. Constants were included in the regressions but are not reported. Absolute
values of robust t -statistics are reported in parentheses. * denotes significant at 10%; ** significant at 5%; and
*** significant at 1%.
398
Appendix A-7
Bank Influence and Alternative Proxy for Demand for Deposit Smoothing
Loan Growth
(1) (2)
Competition from Banks in Neighboring Countries
Low High
(Not Close (Close
to Border) to Border)
Deposit Growth 0.2319** 0.3616***
(2.60) (2.95)
Influence −0.0338 0.2282
(0.08) (0.79)
Deposit Growth* Influence −0.1248*** −0.2200**
(2.67) (2.46)
Log(Total Assets) 0.0596* 0.0280
(1.69) (0.74)
Solvency −0.1549 −0.1689
(0.77) (0.97)
Bank Productivity −1.9262*** −1.4735***
(3.26) (3.81)
Bank Capital Growth 1.6977*** 2.4291***
(3.24) (4.39)
Loan Loss Provisions/Total Assets −0.2305 −0.1130
(0.26) (0.17)
Region-by-Time Fixed Effects YES YES
Bank Fixed Effects NO NO
Clustering by Bank YES YES
R-squared 0.204 0.206
This table examines the effects of influence on the sensitivity of loan growth to deposit growth for banks with
different demands for deposit smoothing. This table complements Table 7. Deposit smoothing demand is proxied
based on whether a bank is operating in a region where it faces competition with banks from neighboring coun-
tries. Banks operating close to the border may face competition from banks operating in nearby countries. This
increased competition may increase the demand for deposit smoothing. We separate banks into those operating
in a region that borders another country and those operating in a region that does not border another country.
For definitions of the variables, see Appendix A-1. The regressions use ten quarters of data (Q2 2005–Q3 2007)
for 181 banks, as we lose one quarter of data (Q1 2005) after including “growth” variables in the regressions.
All standard errors are clustered at the member bank level. Constants were included in the regressions but are
not reported. Absolute values of robust t -statistics are reported in parentheses. * denotes significant at 10%; **
significant at 5%; and *** significant at 1%.
399
Appendix A-8
Determinants of Deposit Growth in Q2 2007 Windfall Quarter
Deposit Growth Abnormal Deposit Growth
(1) (2)
Influence −0.0754 −0.6067
(0.10) (0.87)
Bank Capital Growth −0.1337 0.0069
(0.34) (0.02)
Log(Total Assets) 0.9627 0.6881
(1.44) (1.14)
Solvency −0.8057 0.0040
(0.82) (0.00)
Bank Productivity 0.1730 −0.4087
(0.16) (0.37)
Loan Loss Provisions/Total Assets −5.3693 −4.7049
(1.40) (1.33)
Constant −13.6280 −9.4841
(0.93) (0.71)
R-squared 0.067 0.056
This table examines the determinants of deposit growth in Q2 2007. In column 1, the dependent variable is
deposit growth in Q2 2007. In column 2, the dependent variable is abnormal deposit growth in Q2 2007. It is
calculated as deposit growth in Q2 2007 minus the average deposit growth during the sample period. As a result
of a foreign takeover of a major rival, the banking group observed a large inflow of deposits in Q2 2007. Deposit
growth in this quarter is more than three times its normal level. Absolute values of robust t -statistics are reported
in parentheses. * denotes significant at 10%; ** significant at 5%; and *** significant at 1%.
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Internal Capital Markets and Corporate Politics in A Banking Group

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Internal Capital Markets and Corporate

Politics in a Banking Group

and a headquarters organization.1 In this group’s internal capital market, mem-

and corporate socialism play a role in capital allocations within firms. We

1. Institutional Background, Data, and Methodology

1.2 The Internal Capital Market

from headquarters constitute, on average, a substantial 30% of the total funding

of the group is able to provide an intertemporal smoothing function to its mem-

1.3 Member Bank Influence

1.4 Controlling for Investment Opportunities

Region-by-Time Fixed Effects YES YES YES YES

Observations 1810 1810 1810 1810

changes in transaction account deposits, compared with changes in savings ac-

2.2 Bank Influence and the Internal Capital Market

Deposit Growth −0.0029*** −0.0031*** −0.0032*** −0.0030*** −0.0029*** −0.0029*** 0.0016

Region-by-Time YES YES YES YES YES YES YES

Observations 1810 1810 1730 1760 1810 1810 1810

estimate the “true” votes of a bank in a Tobit regression, in which we assume

influence measure in the regressions (column 5). In column 6, we add a “hy-

(0.31) (0.37) (0.50)

Bank Fixed Effects NO YES YES YES YES YES NO NO

much more pronounced than in banks with influence equal to 1 (a decrease in

2.2.3 Robustness Check: Regression Discontinuity Design. The divergence

Although we control for possible differences in investment opportunities in

(2.12) (2.10) (2.23) (2.14) (1.19) (1.21) (1.40) (1.32)

As a further extension, we look into the possibility of a voting coalition mo-

2.3 Influence and the Demand for Intertemporal Deposit Smoothing

deviation of deposit growth below the median (column 1) or in the bottom

Region-by-Time Fixed YES YES YES YES

Observations 1810 1810 1810 1810

p -value of a Chow test (1) versus (3) (2) versus (4)

In a second analysis, we decompose total loan growth into business loan

of influence by one reduces the impact of deposit growth on business loan

2.4 Windfall Deposits and Different Liquidity Conditions

The substantial relaxing of member banks’ funding constraints in the sec-

Q3 2007 Dummy * Influence * −0.0133 0.1123

Bank Fixed Effects NO NO YES NO NO YES NO NO YES

diversified companies tend to cross-subsidize and support poorly performing

This table provides correlations of the main variables in our dataset.

Influence 0.1313*** 0.1989** 0.1285*** 0.1784*** 0.1258*** 0.2025***

. 1985. What’s Different about Banks? Journal of Monetary Economics 15:29–39.

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Deposit Growth −0.0029* −0.0031* −0.0032* −0.0030* −0.0029* −0.0029* 0.0016

Influence 0.1313* 0.1989 0.1285* 0.1784* 0.1258* 0.2025*