Account. Econ.

Law 2014; aop

Research Article

Olivier Butzbach* and Kurt E. von Mettenheim

Alternative Banking and Theory
Abstract: Unlike business models of private banks based on profit maximization
and shareholder-oriented governance, alternative banks (such as cooperative
banks, government savings banks, and special purpose banks) share business
models based on sustainable returns with longer time horizons, corporate mis-
sions that include social and public policy goals, and stakeholder-oriented
governance. Strong evidence from recent research suggests that alternative
banks often equal or outperform joint-stock banks in terms of efficiency, profit-
ability, and risk management. This counters core ideas in contemporary banking
theory and expectations of regulators about the superiority of private ownership
and market-based banking. Concepts and theories from banking studies help
explain how alternative banks outperform private banks in core functions such
as creating and managing liquidity, pooling deposits, and reducing information
asymmetries and agency costs. However, heterodox theories of the firm and
institutional approaches to competitive advantage broaden the scope of analysis
to explain further historical, social, and organizational advantages (and risks) in
alternative banking. Alternative banks therefore require, and may inspire, alter-
native theories of banking and new approaches to bank regulation.

Keywords: banking, non-profit banks, agency theory, theory of the firm, banking
theory

DOI 10.1515/ael-2013-0055
Table of contents
1 Introduction
2 Defining and differentiating alternative banks
3 Alternative banking history
3.1 Italy
3.2 Germany
3.3 Postal Savings Banks

*Corresponding author: Olivier Butzbach, Department of Political Science, Second University of

Naples, Caserta, Italy, E-mail: olivierkarl.butzbach@unina2.it
Kurt E. von Mettenheim, Department of Social and Legal Sciences, FGV-EAESP, Av. 9 de Julho
2029, São Paulo 01313-902, Brazil, E-mail: kurt.mettenheim@fgv.br

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2 O. Butzbach and K. E. Mettenheim

4 Alternative banks after liberalization, deregulation, privatizations, and IT revolution: a

discussion of empirical evidence
5 Why alternative banks matter
5.1 Alternative banks as institutions for social and economic development
5.2 Alternative banks as buffer for systemic stability
6 Explaining competitive advantages of alternative banks with banking theory15
7 Alternative banking and agency theories of shareholding and market discipline
7.1 Manager–shareholder agency conflicts
7.2 Other agency conflicts
8 Alternative banks mitigate information asymmetries through relationship banking
9 Alternative bank funding, equity, reserves, and patrimony
10 The sustainable business models of alternative banks
11 Alternative banks help smooth inter-temporal risk
12 Conclusions
Appendices
References

1 Introduction
Explanations of the 2007–2008 global financial crisis (Lo, 2012; and the special
issue in this journal: various authors, 2013) and debates about regulation in its
wake rely on implicit or explicit normative assumptions about the business
models of banks. Banks use to be seen as deposit-taking and loan-making
institutions (Allen & Santomero, 2001). However, since Battacharya and
Thakor (1993), contemporary banking theory favors market-based banking in
the sense of banks offering products and services that can be traded on financial
markets to manage risk, price assets and liabilities, allocate credit, and manu-
facture assets (Berger, Molyneux, & Wilson, 2010). Critics of contemporary bank-
ing theory such as Hardie and Howarth (2013a) suggest that market-based
banking caused the recent financial crisis and has slowed recovery since. De
Jonghe (2010) and Gorton (2010) call for a return to narrow banking (traditional
deposit-taking and loan-making). Proposals to separate investment banking
from commercial and retail banking such as the Volcker rule in the US, or
ring-fencing in the UK (UK Independent Commission on Banking, 2011) also
imply a return to traditional banking. However, to date, reforms have been
watered down through compromises with market-based views of banking (Lall,
2012) and appear unable to reverse the trend toward market-based banking in
large private banks.
Remarkably, contemporary academic research on banks and policy debates
both have largely ignored alternative bank groups, large and small, that avoided
the excessive risk-taking and market-based, profit-maximizing business models

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 Alternative Banking and Theory 3

so widely blamed for crisis in 2007–2008. New associations such as the Global
Alliance for Banking on Values1 suggest the importance of initiatives in social
and ethical banking, whatever the form of ownership and governance; and
member institutions have also reported positive performance (Weber, 2013;
Cornée & Szafarz, 2013; Cornée, Masclet, & Thenet, 2012; Weber & Remer,
2011). However, our category of alternative banks (Butzbach & Mettenheim,
2014) covers a much broader population of often very longstanding institutions
such as cooperative banks, credit unions, government savings banks, special
purpose (development) banks, building societies, thrifts, and mutual savings
banks. Although broad, the concept of alternative banking is justified because
these institutions differ from private banks and share business models based on:
(1) disavowal of profit maximization and shareholder-oriented governance; (2)
longer term business horizons involving sustainable returns; (3) business mis-
sions that include social and public goods; and (4) stakeholder-oriented, board-
centered governance.
Several European alternative bank groups strayed from these principles. By
mimicking private bank management strategies, Spanish Cajas de Ahorro (sav-
ings banks) helped drive the real estate boom and bust cycle that has devastated
the country. In Germany, several Landesbanken (provincial government banks)
sought to become global investment banks during the 2000s, only to be caught
in the 2007–2008 crisis. The Austrian Raiffeisen cooperative bank group also
strayed from core principles while expanding commercial operations across
Eastern and Central Europe after the collapse of the Soviet Union, only to retreat
after crisis hit the region in 2008. Likewise, in the UK, aggressive business
strategies at odds with traditional alternative banking models also led to rever-
sals at the Coop Bank in 2012–2013. Government banks in developing and
emerging countries have long drawn criticism for crony credit, poor manage-
ment, and environmental damage. However, many government-owned savings
banks and development banks in these countries have recovered from capture
and mismanagement under military rule and dictatorships to shape growth
amidst democratization and reforms (Mettenheim, 2006); to provide counter-
cyclical credit and adjust (unexpectedly well) to crisis after 2008; and, perhaps
most importantly, to help reach vast numbers of bankless citizens through new
social policies such as basic income (Mettenheim, Diniz, & Gonzalez, 2013).
This article builds on recent empirical research that finds alternative banks
equal to or superior to private banks in terms of efficiency, profitability, risk
management, and other standard criteria used in banking studies. These find-
ings have been reported in many settings, most ironically many years after

1 See references below.

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4 O. Butzbach and K. E. Mettenheim

liberalization, deregulation, privatizations, and foreign bank entry. Instead of

converging toward private, market-based banking, alternative banks have mod-
ernized in a variety of ways to maintain or expand market shares, while seeking
to maintain their peculiar identity and remain faithful to their core missions (see
also Mettenheim, 2013). We explain this anomaly for contemporary banking
theory, neo-classical economic approaches, and neo-liberal policy designs by
focusing on the main features of savings banks, cooperative banks, and govern-
ment special purpose banks. Our explanations of alternative bank performance are
drawn from contemporary banking theory but also from heterodox research on
firms and the institutional foundations of competitive advantage. Concepts from
banking theory reveal how alternative banks perform core functions of modern
banking such as creating liquidity, pooling deposits, reducing information asymme-
tries, and managing agency conflicts. However, heterodox theories of the firm reveal
further institutional foundations of competitive advantages in alternative banking.
Since the 2007–2008 crisis, scholars, the financial press, and policy-makers
have criticized the risky business models of private commercial and investment
banks (Admati & Hellwig, 2013; US Government Financial Crisis Inquiry
Commission, 2011). Although still marginal to policy debates and research in
accounting, political economy and law, the errors of private banks have none-
theless begun to produce reassessment of alternative banks (Butzbach &
Mettenheim, 2014) and raise concern about the loss of organizational diversity
in banking (Michie & Oughton, 2013; Liikanen, 2012; Goodhart & Wagner, 2012;
Ayadi, Schmidt, Llewellyn, Arbak, & De Groen, 2010; Ayadi, Schmidt, & Carbò
Verde, 2009). However, this belated reassessment pales in comparison to dec-
ades of research biased toward private banks and reforms that sought to reduce
or eliminate government and non-profit banks and credit institutions through
privatizations, demutualization, liberalization, foreign bank entry, and deregu-
lation of credit markets that, together, have profoundly changed the competitive
setting for banks and other financial institutions such as pension funds and
investment funds.
The bulk of financial economists and personnel at international policy-mak-
ing institutions expected alternative banks to disappear, either sooner through
privatizations or later because of liberalization; as the latter was expected to
reveal the greater efficiency of private and foreign banks. Alternative bank man-
agers were expected to abandon outmoded traditions of social and state banking
in favor of profit-maximizing, market-based business models taken from private
commercial and investment banks. However, defying expectations, alternative
banking groups have, through a variety of strategies, modernized to hold their
ground – maintaining or gaining market shares in many advanced and develop-
ing countries, especially in retail banking (deposits, savings accounts, and

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 Alternative Banking and Theory 5

lending to small and medium enterprises and households). And empirical studies
have gone beyond descriptive evidence on market shares to demonstrate that
alternative banks have often equaled or exceeded the performance of private
banks in terms of cost, operational efficiency, and profitability. This is a paradox.
As Canning, Jefferson, and Spencer (2003, p. 244) put it, “a central issue is why
not-for-profit banks arise and survive in a world dominated by investor-owned
banks, run for profit”.
This article explains the unexpected persistence of alternative banks as
follows. Section 2 defines alternative banks and differentiates these institutions
from private banks. Section 3 explores the history of alternative banks to
introduce their institutional foundations of competitive advantage. Section 4
summarizes and discusses recent evidence on the (good overall) performance
of alternative banks in the challenging context of a changing bank industry and
regulatory environment over the past decades. Section 5 explores why these
findings about alternative banks matter for socio-economic development and
banking system stability. Section 6 discusses the ability (and limits) of contem-
porary banking theory to explain the competitive advantages of alternative
banks. Section 7 turns to agency theory, the dominant approach in banking
theory and the literature on comparative bank performance, to identify several
important competitive advantages of alternative banks – against the very con-
clusions offered by mainstream banking studies on the basis of their use of
agency theory. However, Section 8 goes beyond agency theory to show how
stakeholder governance embedded in social and political institutions helps
alternative banks better mitigate information asymmetries through relationship
banking. Section 9 further explores how alternative banks obtain funding and
hold equity, reserves, and patrimony differently, and often better, than private
banks. Section 10 summarizes the sustainable business models of alternative
banks. Section 11 reviews evidence that alternative banks help smooth inter-
temporal risk, a critical function of banking systems. The conclusion synthesizes
recent findings to suggest that banking studies may benefit both from analysis of
alternative banks and the institutional foundations of competitive advantage in
banking.

2 Defining and differentiating alternative banks

Our concept of alternative banks encompasses a broad, heterogeneous set of
financial institutions including cooperative banks and savings banks, credit
unions, mutual savings associations, government development banks, and

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6 O. Butzbach and K. E. Mettenheim

special purpose banks. These institutions may appear to have little in common.
How can we compare small British building societies or local (sometimes “single
window”) Italian cooperative banks with financial behemoths such as the
Rabobank or Crédit Agricole? Notwithstanding their differences, alternative
banks share three core characteristics that differ fundamentally from private
banks:

Organizational goals: Alternative banks reject profit maximization for the

benefit of shareholders. This does not mean that alternative banks produce
losses. As discussed below, they have been found by many empirical studies
to be more profitable than for-profit banks. However, the corporate missions of
alternative banks span a broad range of explicitly stated objectives to which
sustainable profits are allocated, such as economic and social development,
local public project finance, savings and credit for poorer households and
small businesses, and long-term investments in public goods, social capital,
and public policies.

Governance structure: The governance of alternative banks is stakeholder-

oriented and board-centered in the sense that they (a) are not run for the
exclusive benefit of shareholders (when they have them); (b) are controlled
and governed by a broader range of stakeholders: members in the case of
mutuals, credit unions, and cooperatives; local and regional governments (and
often clients/citizens) in the case of savings banks; and regional or national
governments in the case of special purpose or development banks; and (c) are
governed by corporate boards that tend to keep executives and staff under closer
supervision and control than private banks.2

Business models: The business models of alternative banks differ from private
banks along two crucial dimensions: (a) more cautious, longer term strategies to
complete social and public policy missions through prudent banking and sus-
tainable returns, and (b) corporate cultures and missions that value the social,
cultural, and economic needs of their geographic areas or functionally defined
members and clients.3

Table 1 compares the stakeholders, corporate missions and local rooting of

private banks with the three major types of alternative banks: government
savings banks, cooperative banks, and special purpose banks.

2 See Section 7 for a discussion of this point.

3 Often, but not always, required in statutes and regulations.

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 Alternative Banking and Theory 7

Table 1: Comparing private banks and alternative banks

Private Savings banks Cooperative banks Special purpose

banks4 banks

Key stakeholder Shareholders Local, regional or Members State agencies

national governments
Mission Profit Provision of savings Pool member National or regional
and banking services resources to secure development;
to citizens; financial and improve access mobilize private
education; local to credit and capital for public
public finance; small sustain local finance; secure
and medium community credit for small and
enterprises finance; development medium enterprises;
social and cultural public policy
project funding implementation
(public housing; local (such as greening of
and regional industry and energy,
development; public human capital)
service provision)
Local rooting5 Weak Strong Strong Medium

These characteristics of alternative banks are mutually reinforcing. The absence

of profit maximization weakens potential residual claims by shareholders; sta-
keholder-oriented governance helps maintain a broad range of corporate goals,
often written in bank statutes and mission statements; stakeholder-oriented
governance and a focus on sustainable returns instead of profit maximization
through risky operations help lengthen the business horizons of alternative
banks; the links of alternative banks to social organizations and government
entities empower social forces and political representatives as stakeholders in
corporate governance. To explain how these characteristics of alternative banks
provide competitive advantages over private banks, we first turn to illustrations
from the long history of alternative banking, then to banking theory and, finally,
to heterodox theories of the firm and institutional foundations of competitive
advantage.

4 The key features of private banks summarized here are taken from banking theory and
theories of the firm discussed below. Private banks may also have social missions that temper
profit maximization for shareholders. However, most large, commercial banks have gradually
shifted toward profit maximization in the past 30 years, as a result of financialization (see
Berger et al., 2010).
5 Understood here as a combination of (i) the importance of local stakeholders in the govern-
ance of the bank and (ii) the local focus of bank activities.

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8 O. Butzbach and K. E. Mettenheim

3 Alternative banking history

Alternative banks emerged alongside private commercial and merchant banking
very early in European history (Mettenheim & Butzbach, 2014). Savings banks
were founded by local governments and entities throughout Europe in the late
eighteenth and early nineteenth century (Mura, 1996). But savings banks remit
further back in history: to early Christian fund management; to the pawn-credit
foundations of religious orders in medieval Italy; and to the Monti di pietà
savings and pawn banks founded throughout Italy in the fifteenth century
(Menhegin, 1986). Raiffeisen and Schultz-Delitz credit cooperatives were
founded across German speaking areas after crop failures and economic crisis
ravaged small farmers and communities in the late 1840s, while Louis Blanc and
Pierre Joseph Proudhon also inspired public and cooperative credit movements
across francophone countries. Development banks were created to finance infra-
structure and accelerate industrialization across Continental Europe in the nine-
teenth century and in many developing countries during the twentieth century
(Aghion, 1999; Zysman, 1983; Diamond, 1957). In Europe (and its colonies),
government postal savings banks rapidly improved access to payment services
and savings accounts after the 1860s.
Some alternative banks were indeed captured in the early twentieth century
by governments that bypassed parliaments to use saving deposits for public
finance and war (Marks, 1905). Fascist and communist governments nationalized,
often by force, the vast branch office networks, and assets and liabilities, of
cooperative banks and savings banks (Castronovo, 2003; Kooper, 1995; Born,
1967). However, after 1945, alternative banks once again proved more positive,
becoming instrumental for recovery from war and sustained growth across Europe
(Shonfield, 1965) to remain critical institutions in complementary relations
(Schmidt & Tyrell, 2001) with public savings and pension programs and other
core features of Welfare States. The following sub-sections draw from the history
of alternative banking groups (especially in Italy and Germany) to illustrate better
their differences from private banks – especially during critical junctures of
national economic development (i.e. before World War I and after World War II).

3.1 Italy
In Italy, alternative banks grew during the nineteenth and twentieth centuries to
retain substantial market shares until market-based reforms in the 1990s trans-
formed most savings banks into joint-stock firms through privatizations. Table 2
reports the credit provided by different types of banks in Italy from 1861 to 1910.

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 Alternative Banking and Theory 9

During this critical period of rapid development and modernization before World
War I, the market share of private banks declines from over half to one third of
total loans provided by credit institutions in Italy. In comparison, savings banks
and Monti di pietà, popular banks and credit cooperatives, and government
special credit institutions all grew to hold substantial lending market shares
during the period of rapid modernization and industrialization in Italy.

Table 2: Italian credit institution loans, 1861–1910 (billion euros)

Year Private, for- Savings banks and Popular banks and Govt. special Total
profit banks Monti di pietà credit coops credit institutes

1861 38.7 38.7 1.5 79.0

1870 47.1 137.4 20.4 23.3 228.3
1880 213.0 234.0 92.7 144.6 684.2
1890 362.3 391.9 209.1 427.0 1,390.3
1900 331.9 367.4 234.4 349.1 1,282.8
1910 1,029.7 857.7 652.1 379.2 2,918.7

Source: De Bonis, Farabullini, Rocchelli, and Alessandra (2012).

Further data are available for later periods that suggest the importance of
branch office networks for alternative banks and relational banking. Table 3
reports the number of branch offices held by different types of banks in Italy
from 1936 to 1966. The private bank share of branch office networks declines
during this period from 81.8 to 47.9%. In comparison, savings banks and Monti
di pietà increased share of branch offices 20.0–28.8%, credit institutes 12.2–
14.7%, popular coops 15.1–16.6%, while rural savings banks lost shares (15.7–
7.9%) and national-interest banks declined slightly (7.9–7.7%). Alternative
banks thereby retained competitive advantage over private banks during the
post-war period of sustained growth and social economy in Italy.

Table 3: Branch offices of types of banks, Italy 1936–1966

Year J-Stock* Credit Other* Credit National Popular Savings Rural Total
cooperatives institutes banks coops and Monti savings
di pietà

1936 1,929 2,215 192 935 607 1,161 1,536 1,202 7,656
1940 1,502 1,696 136 996 577 946 1,664 987 6,866
1950 1,778 1,943 109 1,183 661 1,142 2,131 691 7,751
1960 2,087 2,229 114 1,371 737 1,476 2,632 758 9,203
1966 2,334 2,459 96 1,501 791 1,695 2,940 813 10,199

Notes: * ¼ privately owned banks. Fonte: Banca d’Italia (1977).

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10 O. Butzbach and K. E. Mettenheim

Reforms during the 1990s and 2000s privatized Italian savings banks and
reduced direct government credit channels in favor of private banking. However,
contrary to expectations about private bank efficiency, popular cooperative
banks have kept strong market shares. And, instead of wholesale privatization,
savings bank shares were allocated to new foundations designed to continue the
social and cultural missions of savings banks. This is just one permutation of
bank change across Europe since the 1990s.

3.2 Germany

Since the nineteenth century, studies of banking in Germany use the term “three
pillars” to describe the largely equal market shares held by private banks (pillar
one), cooperative banks (pillar two), and Sparkasse local and regional govern-
ment savings banks (pillar three) (Schmidt, Bülbül, & Schüwer, 2014). The
number of Sparkasse savings banks grew from 85 to 1,765 (mostly local govern-
ment banks) between 1839 and the onset of World War I. Table 4 reports data
from this critical period of rapid development and industrialization in Germany
(1839–1913) before world wars, hyperinflation and depression changed the con-
text of banking. The average balance of savings accounts, number of accounts
per 100 residents, and balances held per capita population suggest that past
debates about savings banks in Germany remain relevant for research on finan-
cial inclusion and social banking today (Schmidt, 2009). Indeed, in the first
Table 4: German Sparkasse savings banks, 1839–1913

Year Banks Branch Accounts Accounts per Balance Average Balance per
(n) Offices (n) (n) 100 residents (million balance million
(marks) marks) (million pop./marks
marks)

1839 85 18 1.24
1845 157 38 2.37
1850 234 278,147 54 195.4 3.29
1855 323 423,542 97 228.7 5.6
1865 517 919,513 268 291.3 13.8
1875 1,005 2,209,101 8.6 1,112 503.4 43.2
1885 1,318 1,485 4,209,453 14.8 2,261 537.1 79.5
1895 1,493 2,448 6,876,664 21.5 4,345 631.9 136.3
1900 1,490 2,828 8,670,709 25.1 5,746 662.6 166.4
1910 1,711 4,619 12,900,304 32.1 11,107 860.1 276.2
1913 1,765 5,268 14,417,642 34.2 13,111 909.4 311.4

Source: Büschegen (1983, p. 399).

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 Alternative Banking and Theory 11

decade of the twentieth century, the “Sparkasse question” turned on whether

the growth of savings deposits at these institutions indicated drift from social
missions that increased risk (because of more volatile middle class and business
deposits), or whether traditional (poorer) clients had instead simply accumu-
lated savings over time. The latter position prevailed, while further debate
ensued about whether the small savings of the poor in savings banks helped
ameliorate, or exacerbate, business cycles (Seidel, 1909).
Until today, German savings banks retain very large market shares in many
markets for banking, insurance, finance, and related services. A core competitive
advantage of savings banks is their “two-tier” structure composed of indepen-
dently owned and operated local banks and a shared wholesale finance group
(the Finanzgruppe Deutscher Sparkassen- und Giroverband, FDSG) that offers
investment banking, finance, and insurance through 631 independent local and
regional savings banks. Wholesale operations of German savings banks emerged
in the late nineteenth century to launch many innovations in capital markets
and finance throughout the twentieth and into the twenty-first century. In 2010,
the balance sheets of German savings banks (reported together as the Sparkasse
Finance Group) summed over 3.4 trillion euros (far more than the largest private
banks in the world), uniting 6,201 firms with 21,700 branch offices and 366,500
employees (See Table 5). Through their multi-level giro organization, German
savings banks cooperate to reduce costs and coordinate to improve monitoring
and control over member banks – mechanisms not available to private banks

Table 5: The German Sparkasse Finance Group, 2009

Firms Branch Staff Total assets

Offices (in bn euro)

Sparkasse Finance Group 6,201 21,700 366,500 3,410

Sparkasse savings banks 631 15,685 258,737 1,073
Landesbank groups 7 50,476 1,689
DekaBank giro center bank 1 3,667 133
Sparkasse insurance group 1 30,000 17
Regional mortgage savings banks 10 8,896 52
Leasing groups 5 10,595 73
Capital market groups 85 1,447 506 2
Factoring groups 3 213 12
Finance IT division 5,375
LBS real estate 10 455 4
Commune management firms 8

Source: Finanzgruppe Deutscher Sparkassen- und Giroverband (2010, p. 2).

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12 O. Butzbach and K. E. Mettenheim

forced to compete by maintaining their own retail networks and wholesale

banking and finance operations individually.
The second pillar of alternative banking in Germany is composed of coop-
erative banking groups that remit to Raiffeissen and Schultz-Delitz credit coop-
eratives founded in the 1840s. Credit cooperatives also grew rapidly during the
nineteenth century; from 133 to 1,245 banks and from 31,603 to 748,058 members
1860–1920. And like savings banks, the trajectory of German cooperative banks
reflects traditional business models of deposit-taking and loan-making, with
conservative levels of capital reserves and members balances. Table 6 shows
this gradual accumulation of savings, assets, (equity) balances for members,
and reserves by commercial credit cooperatives in Germany during the critical
period of rapid development and industrialization from 1860 to 1920 before
hyperinflation and fascism changed banking.

Table 6: German commercial credit cooperatives, 1860–1920

Year Coops Members Asset side Liability side Reserves*

Assets* Loans* Savings Member

Deposits* Balances*

1860 133 31,603 7 1 0

1870 740 314,656 187 166 131 40 4
1880 905 460,656 493 438 353 102 16
1890 1,072 518,003 620 538 438 117 28
1900 870 511,061 806 672 586 133 45
1910 939 600,387 1,477 1,202 1,084 216 94
1920 1,245 746,058 7,158 4,026 6,480 391 164

Note: *Million marks.

Source: Deutsche Bundesbank (1976, p. 66).

The “three pillars” expression actually underestimates the importance of alter-

native banking in Germany because it omits federal and provincial government
special purpose banks that hold an additional 10% market share, depending on
the sector, product, and service (Schmidt et al., 2014; Krahnen and Schmidt,
2004; Deeg, 1999). Table 7 reports the balance sheet, number of staff and
government shareholding structure of the 20 special purpose banks in
Germany in 2010. Together, these institutions held 834.4 billion euros in assets
with 12,730 employees, serving provincial and federal governments by leading
bank consortia and tapping capital markets. German special purpose banks
remain especially important in public and home finance, public building con-
struction, infrastructure modernization, environmental innovation, the greening
of industry, and provision of health and other public services.

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 Table 7: German special purpose banks, 2010

Staff Balance Majority shareholding**

sheet*

Federal government special purpose banks

KfW Bank Group 4,600 400.1 80% Fed. 20% State Govts.
Landwirtschaftliche Rentenbank 218 75.8 Fed. Govt.
State government special purpose banks
Investitionsbank Schleswig-Holstein 460 16.7 Schleswig-Holstein
Bremer Aufbau-Bank 55 1.3 Bremen Holding
Hamburgische Wohnungsbaukreditanstalt 185 5.1 Hamburg
NBank Invest. und Förderbank Niedersachsen 426 5.7 Niedersachsen
NRW Bank (Nordrhein-Westfalen Bank) 1,224 161 98.6% Nordrhein-Westfalen
Investitions- und Strukturbank Rheinland-Pfalz 186 8.5 Rhein-Pfalz
LTH, Landestreuhandbank Rheinland-Pfalz 98 1.9 Rhein-Pfalz
SIKB Saarländische Investitionskreditbank 66 1.2 51% Saar
L-Bank, Landeskreditbank Baden-Württemberg 1,230 59.7 Baden-Württemberg
LfA Förderbank Bayern 344 19.4 Freistaat Bayern
Bayerische Landesbodenkreditanstalt 227 21.2 Bayrischen esbank
Landesförderinstitut Mecklenburg-Vorpommern 246 2.5 NORD LB
Investitionsbank Berlin 673 20.4 Berlin
Investitions Bank des Landes Brandenburg 505 11.8 50% Brandenburg, 50% NRW Bank
Investionsbank Sachsen-Anhalt 349 1.3 NORD/LB
Thüringer Aufbaubank 336 2.5 Freistaat Thüringen

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Sächsische Aufbaubank Förderbank 905 8.7 Freistaat Sachsen
Wirtschafts- und Infrastrukturbank 397 9.6 Landesbank Hessen-Thüringen
Alternative Banking and Theory

Total 12,730 834.4

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Note: *billion euros **100% where percentage not reported.
Source: Association of German Public Sector Banks (Bundesverband Öffentlicher Banken Deutschlands, VÖB).
13

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14 O. Butzbach and K. E. Mettenheim

Some regional Landesbanks were caught in the crisis or succumbed to

corruption, leading observers of German finance to call for ending links between
savings banks and special purpose banks (Hilgert et al., 2011). However, not all
German special purpose banks incurred losses and, as a whole, appear to have
been important sources of counter-cyclical finance and credit since the 2007–
2008 global financial crisis. Table 8 reports the lending of German special
purpose banks from 2008 to 2012; total investments increased from 6.7 to 9.0
billion in 2008–9, just as private banks incurred major losses from exposures in
capital markets (Hardie & Howarth, 2013b).

Table 8: German special purpose bank finance and credit, 2008–2012, million euros

Sector 2008 2009 2010 2011 2012

Commercial 3,851.2 4,611.4 3,913.6 3,581.0 3,430.4

Local government 1,030.2 1,826.5 1,249.8 1,247.4 823.7
Home and public construction 835.3 1,173.8 983.9 1,020.9 785.7
Agriculture and agroindustry 91.3 386.7 386.2 379.4 387.1
Other 976.8 109.4 1,141.9 1,003.5 944.1
Total 6,784.7 9,092.9 7,675.4 7,232.2 6,371.0

Source: Bundesverband Öffentlicher Banken Deutschlands (2013, p. 2).

Data on bank performance reported by the German central bank also suggest the
competitive advantages of alternative banks (see Table 9 and appendices). One
clear advantage of alternative banks is cheaper administrative costs than private
banks. Given the lean central offices of special purpose banks, the cost–income
ratios6 of these institutions declined from 47.9 in 1970 (vs 84.5 at big private
banks and 70.0 at Landesbanks) to 32.2 in 2010 (vs 83.1 at big private banks and
57.9 at Landesbanks). And because savings banks and cooperative banks reduce
costs by sharing wholesale operations, the latter also report cost–income ratios
below large private banks and reduced this crucial indicator of bank perfor-
mance from 1970 to 2010 (from 74.3 to 63.0 and 70.4 to 64.5, respectively) (see
Table 9).
However, before turning to further evidence of recent performance, a histor-
ical introduction to alternative banking would be incomplete without mention of
government postal savings banks.

6 The cost–income ratio is calculated as total administrative spending divided by gross earn-
ings (aggregate net interest and net commissions received).

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 Alternative Banking and Theory 15

Table 9: Cost–income ratios by type of German bank, 1970–2010

Year Private Big Regional Savings Coops Government Sp. Purpose Landes

1970 84.5 76.8 74.3 70.4 47.9 70.0

1980 85.9 80.3 68.7 72.7 50.5 72.5
1990 69.7 77.4 67.9 76.5 71.0 66.0
2000 93.4 76.4 69.0 76.1 30.5 62.7
2010 83.1 69.2 63.0 64.5 32.2 57.9

Note: Cost–income ratio ¼ Total administrative spending/gross earnings (aggregate net interest
and net commissions received).
Source: Deutsche Bundesbank (2013). Available on www.bundesbank.de.

3.3 Postal Savings Banks

After the UK Postal Savings Bank was founded in 1862, governments throughout
Europe began to offer savings accounts and other banking services through the
vast branch office networks of postal agencies. Postal savings banks rapidly
acquired large numbers of depositors and mobilized large quantities of savings.
From 1862 to 1908, the UK Postal Savings Bank increased branch offices from
2,535 to 15,239, depositors from 178,495 to over 11 million (over 25% of the
population), and deposits from 8.2 to 781.8 billion US dollars7 (Table 10).
Postal savings banks experienced similar rapid growth throughout Europe
and European colonies before World War I (National Monetary Commission,
1909).
After independence from colonial rule, postal savings banks were often
retained by governments in developing countries for their large branch office
networks and high ability to mobilize savings and facilitate payments and
service provision. Countries that closed postal banks have recently recreated
them. The creation of the China Postal Savings Bank in 2007 (with over 40,000
branch offices) and resale of banking concessions inside the 6,000 Brazilian
postal offices in 2011 suggest the continued importance of postal banks with
profound opportunities (and risks), especially for financial inclusion. In Africa,
post-independence governments used postal offices to promote access to pay-
ment and banking services toward poverty alleviation (Kamawe-Tsafack, 2002).
Indeed, to counter the dramatic increase of financial exclusion in the US, the
postal service has, once again, proposed expanding non-bank financial and

7 Data in dollars, facilitating comparison, were calculated according to foreign exchange rates
by US consulate officials at that time for the US National Monetary Commission.

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16 O. Butzbach and K. E. Mettenheim

Table 10: Postal Savings Banks, UK, France, and Italy, 1862–1908

Year Offices Depositors Deposits (US$)

UK Postal Savings Banks, 1862–1908

1862 2,535 178,495 8,264,392
1870 4,082 1,183,153 73,479,789
1880 6,233 2,184,972 164,218,275
1890 9,681 4,827,314 329,145,788
1900 13,341 8,439,983 659,652,347
1908 15,239 11,018,251 781,794,533
France Postal Savings Bank 1882–1908
1882 6,024 211,580 9,187,116
1890 6,817 1,475,820 79,793,736
1900 7,697 3,565,941 194,980,796
1908 5,291,673 296,964,867
Italy Postal Savings Bank, 1876–1908
1876 1,989 57,354 471,577
1880 3,313 339,845 8,926,802
1890 4,479 2,126,289 59,923,342
1900 5,143 3,990,983 131,652,255
1908 8,735 4,981,920 290,808,886

Note: Dollar values calculated by US consular staff reporting to the National Monetary
Commission. Time series ends the year before the Commission report.
Source: National Monetary Commission (1909, pp. 34–44).

payment services at branch offices.8 Although closed because of opposition by

private banks in 1967, the US Postal Service Savings System had provided
widespread access to basic savings since its creation in 1911 (Kemmerer, 1917).
Postal savings banks remain critical institutions for promoting savings and
averting financial exclusion.
In sum, alternative banks have played important roles in a variety of bank-
ing and financial systems since the nineteenth century, especially in terms of
promoting financial inclusion, mobilizing savings and public finance. Given the
long history and wide variety of alternative banks, it is difficult to measure the
overall importance of these institutions. Industry associations such as the World
Savings Banks Institute and the International Co-operative Banking Association
provide information about member banks, but no aggregate data exist for public
development banks, despite their size and importance in many advanced and

8 On proposals by the USPS, see: Office of the Inspector General, USPS (2014). On financial
exclusion in the US, see FDIC (2012).

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 Alternative Banking and Theory 17

developing countries. Moreover, because alternative banks vary widely across

sectors, countries, and regions, these institutions may not appear in standard
aggregate measures of banking activity. For example, according to the overall
market shares of UK bank deposits in the 1990s, mutual building societies
appear marginal while, in fact, they remained dominant players on the mortgage
lending market.
Differences across world regions also are marked. While local and regional
savings banks and cooperative banks predominate across Continental Europe
(Groeneveld, 2014; Schmidt et al., 2014); development banks and savings banks
or institutes were centralized in developing and emerging countries, often by
military or authoritarian governments (Mettenheim, 2014).
It is thus fair to say that given the importance of alternative banks in some
segments of banking and many financial systems, these institutions have indeed
been historically significant and deserve more attention in research on banks
and banking.

4 Alternative banks after liberalization,

deregulation, privatizations, and IT revolution:
a discussion of empirical evidence
Even where alternative banks retained large market shares and critical roles in
banking and finance, fundamental changes in the legal, regulatory and competi-
tive environment of banking appeared to threaten their survival after 1980.
Reforms in many countries radically altered banking through: (a) de-segmentation,
in the sense of ending strict separation between segments of banking markets such
as short-term money markets and long-term lending; household and corporate
lending; and retail and wholesale banking (for example, the 1999 Gramm-Leach-
Bliley Act in the US, which repealed core provisions of the Glass-Steagall Act
restricting affiliations between deposit banks and trading firms); (b) financial
market liberalization that reduced legal and regulatory barriers to entry; (c) liberal-
ization of credit markets and prices that sought to reduce or end administered
credit in state-centered financial systems such as France or Italy (or abandon
informal interest rate controls in countries such as the UK); (d) statutory normal-
ization designed to end protection of alternative banks (usually leading to their
transformation into or merge with joint-stock banks; for example, the Building
Societies Act of 1986 allowed British building societies to demutualize; or the 1990
Amato-Carli law in Italy that transformed savings banks and other public banks

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18 O. Butzbach and K. E. Mettenheim

into joint-stock companies); and finally (e) large-scale privatizations of state-owned

banks in countries with traditions of state-owned enterprises such as France and
Italy in Europe, as well as many developing, emerging, and transition countries.
Liberalization, deregulation, privatizations, and mergers and acquisitions
have radically changed banking and finance. Banks and other financial inter-
mediaries such as insurance companies and investment funds shifted business
away from traditional deposit-taking and loan-making toward a wide variety of
products and services traded directly on capital markets. New technologies of
information and communication also revolutionized banking with new electro-
nic channels such as ATMs, online banking and mobile banking via cellular
phones – technologies that bypass traditional branch offices and personal, face-
to-face provision of services traditionally associated with relational banking (see
below).
These fundamental changes have challenged all banks, but alternative
banks most dramatically. Privatizations transformed many alternative banks
into joint-stock corporations, often abruptly ending traditional governance struc-
tures and practices. For example, building societies, a non-profit pillar of the UK
financial system, were largely dismantled after reforms in 1986 allowed the most
powerful societies to demutualize. These demutualized building societies formed
the backbone of for-profit banking groups that played central roles in exacer-
bating the 2007–2008 banking crisis (Northern Rock, Halifax, Bradford, and
Bingley). Liberalization of banking and credit markets and waves of consolida-
tion through mergers and acquisitions forced many local cooperative banks and
savings banks to merge with or be acquired by larger for-profit banks. This
process was most marked in the UK and Italy.9 Finally, foreign bank entry and
financial market liberalization encouraged all banks to diversify away from
traditional business lines and pay more attention to short-term profit margins.
Although widely expected to reveal the greater efficiency of private banks,
alternative banks appear to have adopted new technologies through moderniza-
tion strategies capable of tapping their traditional competitive advantages.
As a result of these far-reaching changes in their competitive, technological,
and regulatory environment, the fate of alternative banks has differed. In the US
and UK, traditional savings and cooperative banks have been marginalized,
either through collapse of the sector during transition to market-based banking
(the US Savings and Loan crisis in the late 1980s) or demutualization (the 1986

9 In the UK, most large building societies choose to demutualize and then merge with large
joint-stock commercial banks in the 1990s; in Italy, most large savings banks, once granted a
joint-stock status, merged with former public banks to form the backbone of the country’s
largest joint-stock banking groups, Intesa SanPaolo and Unicredit.

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 Alternative Banking and Theory 19

Building Society Act led large UK building societies to demutualize, thus causing
the cooperative movement in UK banking to shrink four fifths of its total assets
during the 1990s). However, alternative banks kept large market shares in many
other countries, both in lending and in retail funding markets, especially in
Continental Europe. In France and Germany, cooperative banks and savings
banks retain dominant positions. As mentioned above, alternative banks con-
stitute two of three pillars in German banking. In Italy, 5 of the largest 10
banking groups (in assets) are cooperative banks (Banche Popolari). In the
Netherlands, after declining during the 1990s, the cooperative group Rabobank
recovered over the next decade to remain the second largest bank in the country.
Alternative banks also retain powerful market positions in many developing
countries. In large emerging countries such as Brazil and India, state-owned
banks remain the largest and fastest growing banks long after liberalization and
privatizations (Mettenheim, 2014).
However, the evidence goes beyond market shares. In the appendix, Table
16 summarizes the findings, research methods and data of 21 empirical studies
that compare the performance of alternative banks, mostly in terms of cost-
efficiency, profitability, and riskiness. Overall, these studies provide strong
evidence from diverse settings that alternative banks can compete with and
also outperform private banks, even after liberalization, deregulation, and adop-
tion of new technologies. In particular, these studies find cooperative banks and
savings banks to be at least as cost-efficient10 as their commercial competitors.
Ayadi et al. find European savings banks as much cost-efficient as commercial
banks (2009). Although German cooperative banks appear slightly less cost-
efficient, cooperative banks in France, Italy, and Spain are largely more cost-
efficient than their commercial peers (Ayadi et al., 2010). This confirms findings
from Iannotta, Nocera, and Sironi (2007) showing that government-owned and
cooperative banks are more cost-efficient in 15 European countries (in a sample
of 181 large banks). Altunbaş, Carbó Valverde, and Molyneux (2003) also find
slightly higher cost-efficiencies with savings and cooperative banks in a sample
study of banks in 15 European countries and the US 1990–2000. Savings and
cooperative banks were found to be more cost-efficient than private banks in all
but three countries. Country studies such as Altunbas, Evans, and Molyneux
(2001) on Germany, Giordano and Lopes (2009) on the Italian cooperative sector,

10 Cost-efficiency is defined here as the ability of banks to minimize the cost of inputs for a
given output. Of course, this rather narrow view raises a number of questions as to what is the
implicit business model underlying these efficiency measures. The theoretical and methodolo-
gical biases of bank performance studies are addressed in other sections below.

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20 O. Butzbach and K. E. Mettenheim

and Cebenoyan et al. (1993) on the US savings and loans sector obtained similar
results.11
Alternative banks also perform well in terms of profitability. Again, this is
surprising because they do not focus on profit maximization. Indeed, Berger
et al. warn against using measures of profitability to compare government banks
with private banks because “the measures of performance and economic con-
sequences employed in these studies do not always correspond to the objectives
of the state-owned banks” (Berger, Clarke, Cull, Klapper, & Udell, 2005). This
caveat applies to studies of savings banks and cooperative banks that emphasize
profitability and casts doubt on comparisons between alternative banks and
private banks based on measures drawn from joint-stock firms (such as stock
returns used by Cole and Mehran (1998) on a sample of US thrift institutions).
More appropriate measures for analysis of alternative banks may be found in
studies of cooperative institutions or non-profit organizations; while other expla-
nations of performance (such as alternative bank specialization in more tradi-
tional, safer, and profitable lines of business such as retail and mortgage
lending) need to be explored.
Notwithstanding these problems of inappropriate measurement and com-
parison, alternative banks still fare well in recent studies of profitability. Dietrich
and Wanzenried (2011) find that Swiss government-owned banks performed
better than privately owned commercial banks during the crisis years (2007–
2010), while pre-crisis performance was at par.12 Millon Cornett, Guo, Khaksari,
and Tehranian (2010) present mixed evidence on the comparative performance
of government banks. Studying a sample of East Asian banks from 1989 to 2004,
the authors find that state-owned banks were less profitable, held less core
capital, and had greater credit risk than privately owned banks prior to the
1997 crisis.13 However, East Asian government banks have approached private
bank levels of performance since the 1997 financial crisis in Asia. Micco,
Panizza, and Yañez (2007) find that state-owned banks in developing countries
are less profitable than private-owned banks. However, Bonin, Hasan, and

11 An exception is Mester (1993) who finds, on the contrary, in a sample of more than a 1,000
US savings and loans surveyed in 1988, that joint-stock savings and loans outperform their
mutual peers in terms of cost-efficiency.
12 An anonymous referee suggests that this is because state banks were prohibited from
international banking.
13 However, it should be said that lower or higher credit risk are affected by risk measurement
methods, themselves associated with bank regulations such as core capital requirements under
Basle agreements. We thank an anonymous reviewer for raising this point.

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 Alternative Banking and Theory 21

Wachtel (2005) find significant differences between state banks and private
banks in Eastern Europe in terms of profit efficiency. An earlier comparison of
European banks found, on average, that state banks posted higher returns on
assets than private banks (Molyneux & Thornton, 1992). Aggregate comparisons
of public and private banks after the 2007 crisis also become difficult because
nationalizations or public rescue of banks undercut this dichotomy.
Ayadi et al. (2010) find German and Spanish cooperative banks more profit-
able than commercial banks in terms of returns on assets and equity. However,
this does not hold for cooperative banks in other European countries. After
excluding small cooperative banks and savings banks, Iannotta et al. (2007)
find that government-owned banks and cooperative banks perform worse than
private, commercial banks in terms of profitability and riskiness. Altunbas et al.
(2003) also find that European commercial banks are slightly more profitable
than their non-profit peers. However, these findings from comparative studies
are reversed in several analyses of specific countries: Chakravarty and Williams
(2006) on Germany, Crespi, Garcia-Cestona, and Salas (2004) on Spain, Altunbas
et al. (2001) on Germany, Valneck (1999) on British building societies, and
Cebenoyan, Cooperman, Register, and Hudgins (1993) on the US all find non-
profit banks to be more profitable than for-profit banks.
Results from comparison of risk management in alternative banks and
private banks are also mixed. Standard measures of bank risk such as z-scores,
which measure default probabilities, or earnings volatility produce mixed
results. Studies by La Porta, Lopez-de-Silanes, and Schleifer (2002), Millon
Cornett et al. (2010), and Iannotta et al. (2007) find government-owned banks
(but not cooperatives in the latter case) to be less stable; while Ayadi et al.
(2009, 2010), Beck, De Jonghe, and Schepens (2012), Bongini and Ferri (2008),
Garcia-Marco and Robles-Fernandez (2008), Cihak and Hesse (2007), Iannotta
et al. (2007), Salas and Saurinas (2002), and Esty (1997) all report higher earn-
ings stability for cooperative banks and savings banks than in private banks.
Ayadi et al. (2009), Beck et al. (2012), and Garcia-Marco and Robles-Fernandez
(2008) find lower probabilities of default in cooperative banks and savings
banks compared to private banks.
Comparisons of credit risk also find cooperative banks and savings banks to
have fewer non-performing loans than commercial banks (Beck et al., 2012;
Salas & Saurina, 2002). Data from the Central Bank of Brazil suggest that levels
of non-performing loans in Brazilian government banks fell from very high
levels under military rule and transition governments to well below levels of
private banks in the country after transition to democracy during the 2000s
(Mettenheim, 2010). Although it is difficult to control for the practice of rolling
over bad loans to reduce levels of non-performing loans, data from the Reserve

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22 O. Butzbach and K. E. Mettenheim

Bank of India also suggest that the level of non-performing loans at state banks
has converged to private bank levels during the 2000s (Mettenheim, 2014).
In sum, comparative statistical analyses bolster the idea that alternative
banks have realized competitive advantages over private banks. Despite the
profound changes in banking produced by liberalization, deregulation, and
new technologies since the 1980s, alternative banks in many countries have
not only survived; they have fared well on the basis of standard indicators of
performance in empirical comparisons with private banks. Using more adequate
measures to assess alternative bank performance (such as counter-cyclical lend-
ing or credit rationing) also produce findings favoring these institutions over
private banks (Schclarek-Curutchet, 2014). However, most studies still use stan-
dard measures of bank profitability, efficiency, and risk management taken
directly from the literature on private banking.14 This is a tough test suggesting
that alternative banks do indeed compare well with private banks.
Before turning to theories of banking and the institutional foundations
of competitive advantage to explain why alternative banks perform as well
or better than private banks, a note on why alternative banks matter is in order.

5 Why alternative banks matter

Alternative banks matter because they counter the credit rationing of private
banks (Bresler, Grossle, & Turner, 2007), help avert capital drain (Hakenes &
Schnabel, 2006), and promote financial inclusion by serving poor and geogra-
phically isolated citizens that private banks increasingly refuse to retain as
clients (Federal Deposit Insurance Corporation, 2012). Alternative banks also
provide important institutional resources for social and political forces and
policy options for governments. And given the hard realities of fiscal constraints
in advanced and emerging economies, it is essential to recognize that govern-
ment banks can dramatically increase funding for public policies (banks do
create money, after all) and improve policy implementation by monitoring and
control public projects (Biondi, 2013; Mettenheim, 2010).

14 Whether this provides tough tests that indicate competitive advantages in alternative bank-
ing or, instead, that alternative measures and alternative theories are needed is a question we
return to below.

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 Alternative Banking and Theory 23

5.1 Alternative banks as institutions for social and

economic development

Two functions of alternative banks stand out in social and economic develop-
ment: enlarging access to banking services and funding economic activities. The
core mission of credit cooperatives and savings banks (since their emergence in
the nineteenth century) is to encourage savings among popular and working
classes and meet the financial needs of low- and middle-income members and
citizens. Cooperative banks and local and regional government savings banks
still specialize in retail lending (to households and small firms) and holding
deposits of low- and middle-income households. Despite increased competition
for deposits (and low interest rates set by central banks since 2008), cooperative
banks and savings banks nonetheless retain large shares of retail bank deposit
markets.
Cooperative banks and savings banks have also played a key role in chan-
neling savings to public finance through government securities and encouraging
home ownership in many European countries since the nineteenth century. In
advanced and emerging economies, public development banks retain explicit
mandates to finance a broad array of public goods and projects, ranging from
funding small and medium enterprises to financing social housing and local and
regional economic development.

5.2 Alternative banks as buffer for systemic stability

Alternative banks also improve the overall functioning of financial systems,

especially systemic stability. Recent research on diversity in banking develops
three arguments relevant for understanding how alternative banks may improve
the stability of banking and financial systems (Ayadi et al., 2010, 2009; Haldane
and May, 2011). The first argument simply notes the importance of diverse
business models within and across banking systems, especially in terms of
organizational purpose and risk management. Such arguments can be found
in recent studies of alternative banks cited above and official government
reports, such as the UK Treasury report on financial regulation (HM Treasury,
2010); or the Liikanen Report for the European Commission that defines six
dimensions of diversity in banking (size, ownership, capital and funding, activ-
ities revealed by balance sheets and income statements, corporate and legal
structure, and geographical scope) (Liikanen, 2012). Michie and Oughton (2013)
emphasize bank diversity in terms of ownership (shareholding structure), com-
petition (market structure), balance sheet resilience, and geographical spread.

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24 O. Butzbach and K. E. Mettenheim

The second argument is that diversity is valuable in itself as a characteristic

of the banking sector as a whole. In other words, banking systems composed of
heterogeneous organizations do better at mitigating systemic risk than homo-
geneous banking systems, whatever the source of heterogeneity. This point is
very similar to the view that homogeneous banking systems suffer from a too-
many-to-fail problem, whereby an implicit guarantee by governments “induces
banks to herd ex-ante in order to increase the likelihood of being bailed out
ex-post” (Acharya & Yorulmazer, 2007).
More broadly, diversity helps reduce systemic risk by reducing the collinear-
ity of bank portfolios. Indeed, one reason behind the global financial crisis of
2007–8 was that banks invested in the very same asset classes (such as mort-
gage assets) because of the high correlation of diversification strategies at
banks. In other words, too many banks chose to diversify their revenue in
similar ways. As Haldane (2009) famously pointed out, individual diversification
by banks may decrease systemic diversity and increase systemic risk. This has
been confirmed by Corsi, Marmi, and Lillo (2013) and explained further as
phenomena driven by market-based banking in Minskyian cycles of financial
instability by Solomon and Golo (2013). Wagner makes related argument that the
homogenization of banking systems has reduced the ability of banks to share
risk, such that the re-optimization of bank portfolios tends to disrupt liquidity
creation in the banking system (Wagner, 2010, 2008; Goodhart & Wagner, 2012).
Biondi and Fantacci (2012) further demonstrate how liquidity was designed as a
market-based process driven by use of fair value accounting (instead of histor-
ical cost accounting) that has culminated in increased market distress and
massive injections from monetary authorities to preserve liquidity. These studies
go beyond typologies and differences in organizational forms of banks to iden-
tify the importance of diversity in the industry.
A third argument suggests that diversity is important for the evolution of
banking systems. For Michie (2011, p. 309), “In a situation of uncertainty and
unpredictability, we cannot know which model will prove to be superior in all
possible future circumstances, so we ought to be rather cautious before destroying
any successful model.” Arguments about banking diversity do not imply support
for alternative banks per se. However, they do suggest that alternative banks
improve banking and financial systems – especially because their lower levels
of exposure to markets and smaller size may allow them to better withstand
adverse economic conditions (Vallascas & Keasey, 2012; De Jonghe, 2010).
In terms of the “three pillars” description of German banking, banking
systems that rely exclusively on one pillar (private, market-based banking) may
well be less stable than banking systems that retain two further pillars, i.e. large
groups of independent local and regional cooperative banks and savings banks.

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 Alternative Banking and Theory 25

6 Explaining competitive advantages of

alternative banks with banking theory15
To go beyond metaphors and explain why alternative banks have outperformed
private banks so consistently, one naturally turns to theories of banking.
However, contemporary banking theory, as presented, for instance, in the
Oxford Handbook of Banking (Berger et al., 2010), or textbooks (Matthews &
Thompson, 2008), provides very scant reference to savings banks, cooperative
banks, or government banks. None of the 36 chapters of the 2010 Handbook deal
with alternative banks or non-profit financial intermediaries. Savings banks and
mutual banks are absent from the Handbook index; cooperative banks appear
twice (in a chapter on Japan); development banks once (the Development Bank
of Japan); thrift institutions twice in a chapter on the US alongside an entry on
thrift failures; and state-owned commercial banks four times in a chapter on
transition countries. Ignoring alternative banks in a handbook published three
years after the 2007 global financial crisis indicates a glaring omission in main-
stream banking studies. However, heterodox theories of banking seem to share
the same apparent lack of interest in alternative banks (Nasica, 2010; Bertocco,
2006), even when the purpose of analysis is to reassess what banks should do
(Wray, 2013; Dymski, 1988). And while economists did pay more attention to
non-profit financial intermediaries in the past, research focused almost exclu-
sively on governance and ownership issues.16
A closer look at contemporary banking theory helps explain this lack of
interest in alternative banking but, ironically, also suggest that core ideas from
banking theory may nonetheless clarify certain competitive advantage of alter-
native banks. First, modern theories of banking in the 1960s ignored alternative
banks because they sought to go over neo-classical theories of fractional reserve
banking. The latter were primarily theories of money. Accordingly, banks
remained a sideshow to monetary authorities as simple cogs in the money
multiplier. Banks were seen as money creating entities with no significant
contribution to the economy. The “new view” in banking theory thus emerged
as a reaction against this “pure theory of fractional reserve banking” (Towey,
1974). These new approaches (Tobin, 1963; Gurley & Shaw, 1960) made two key
arguments. First, they rejected what Tobin called the mystique of money. For
Tobin, substitutability (from the borrowers’ point of view) between financial

15 The following sections build on Butzbach and Mettenheim (2014).

16 As Rasmussen put it 25 years ago: “the difference between mutual and stock banks lies in
who controls the bank and receives the profits” (Rasmussen 1988, p. 395).

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26 O. Butzbach and K. E. Mettenheim

assets required the rejection of money as special. Second, Tobin and others
argued that banks are firms with specific corporate goals: “Bank-created ‘money’
is a liability, which must be matched on the other side of the balance sheet. And
banks, as businesses, must earn money from their middleman’s role” (Tobin,
1963, p. 416).17 Modern theories of banking thereafter emphasized that bank
assets and liabilities were shaped by the strategies of bank managers to max-
imize returns from lending and interest rates on deposits (Tobin, 1982;
Santomero, 1984). Lending was thus seen to be determined by the marginal
returns of assets over the cost of liabilities (Klein, 1971).
New theories from Tobin, Gurley, and Shaw sought to reinstate a more
realistic view of banking within monetary theory; their primary focus was not
to offer a better understanding of banks per se. Banking theory developed,
therefore, as a secondary endeavor and largely followed two parallel theoretical
tracks. First, Tobin was a Keynesian and his monetary theory was neo-
Keynesian. However, his, and other, new views of banking applied old assump-
tions from neo-classical theories of the firm to banks and financial institutions
(utility maximization and self-interest taken, in turn, of course, from neo-classi-
cal assumptions about individuals). Second, banking theory explained banks in
terms of their functions in financial systems of money-based economies. Tobin
extrapolated from the monetary role of banks with a portfolio approach: “the
essential function of financial intermediaries […] is to satisfy simultaneously the
portfolio preferences of two types of individuals or firms” (1963, p. 411).
Research in banking theory and financial economics has since retained the
assumptions of mainstream firm theory to elaborate specific functions of banks
(Fama, 1980a; Diamond & Dybvig, 1983; Baltensperger, 1980; Wray, 2013). This
approach to banks as multi-function, profit-maximizing firms has distanced
banking theory from institutional and organizational approaches in other dis-
ciplines. In their landmark synthesis, Bhattacharya and Thakor (1993) suggest
that banks fulfill two key functions in modern financial systems: brokerage
services and qualitative asset transformation. By focusing on banks as interme-
diaries between investors and capital markets, contemporary banking theory has
largely ignored, in peril, traditional views of how banks manage maturity

17 As a reviewer pointed out, Tobin’s ideas reflect a very reductive “balance sheet approach” to
the banking firm, i.e. one that conceives assets and liabilities as marketable securities and sees
the banking firm as a mere portfolio of such assets and liabilities. We completely agree with this
critical assessment of the “new view”. But our purpose here is precisely to highlight the
limitations of contemporary banking theory by questioning its core assumptions – while
retaining certain arguments within this overall questionable framework that may usefully
explain certain aspects of alternative banks’ competitive advantage.

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 Alternative Banking and Theory 27

transformation.18 In contrast, we return to traditional conceptions of banks (as

deposit-taking and loan-making institutions that must balance assets with
liabilities) to reject the idea that financial intermediation allows market-based
banks to manufacture and manage assets above and beyond traditional capital
reserve levels that have long been seen as necessary to cover possible losses
from risks.
For contemporary banking theory, market efficiency implies that price sig-
nals from capital markets may replace soft information and relationship banking
embedded in social and political institutions. An institutional theory of alter-
native banking suggests, to the contrary, that competitive advantages arise from
traditional balancing of liabilities and assets that permit maturity transformation
through size, scale, confidence, organizational reputation, internal monitoring,
and supervision (that averts excessive risk-taking and opportunistic marketing
and sales) and, in the past, guarantees from mutual arrangements or govern-
ment entities. This differs from the core concept of qualitative asset transforma-
tion in contemporary theories of banks as financial intermediaries that focus on
how bank loans retain different risk profiles than the liabilities issued by banks
to make those loans (Diamond & Rajan, 2001). Recent research shifts from
relational to transactional views of banking (Boot & Marinč, 2008) and the
integration of banks and markets (Boot & Thakor, 2010), but focuses on func-
tions of brokerage and asset transformation that assume neo-classical theories of
the firm and see banks as intermediaries between investors and capital
markets.19
Two significant developments in contemporary banking theory emerged in
the 1970s: one emphasizing market failures, another focusing on changes in
governance by banks driven by shareholders.20 The literature on market failures
in banking retains core assumptions about market efficiency. And studies of
bank governance retain core assumptions about the virtues of shareholder-based
governance in mainstream theories of the firm. However, both nonetheless help
identify several competitive advantages of alternative banks, especially if sup-
plemented with findings from past research on non-profit banks and credit
institutions.

18 The authors thank Yuri Biondi for suggesting this critical point.
19 However, in analyzing this shift in behavior, economists ignore the important role of top-
down regulatory reforms and changes in accounting standards. Thanks to an anonymous
referee for this useful comment.
20 The authors thank Yuri Biondi for this synthesis of turns in banking theory and their
importance for rethinking alternative banks from an institutional perspective.

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28 O. Butzbach and K. E. Mettenheim

The turn to market failures in banking theory focused on information asymme-

tries (see Leland and Pye, 1977). For Boot (2000, p. 8), the theory of information
asymmetries helps distinguish “modern theories of financial intermediation from
the earlier transaction costs-based theories”. From this perspective, banks exist
because “intermediation is a response to the inability of market-mediated mechan-
isms to efficiently resolve informational problems” inherent to financial transac-
tions (Bhattacharya & Thakor, 1993, p. 14). The specificity of banks is then in the
type of contractual mechanism used to solve information asymmetries. While for
Tobin (1963; 1982), banks helped decrease transaction costs through the pooling of
risk, modern theories insist on the informational advantages of banks over markets
as critical to reduce credit rationing (Stiglitz & Weiss, 1981). Banks were thereby
seen as delegated monitors able to reduce the cost of monitoring borrowers incurred
by lenders/depositors (Diamond, 1984). From this perspective, banks undertake
relationship lending to decrease information asymmetries and avert the conse-
quences of information asymmetries on credit relationships: adverse selection
and moral hazard (Boot, 2000; Petersen & Rajan, 1994).
These views of market failures, banks as intermediaries, and relationship
lending help clarify the competitive advantages and broader importance of
alternative banks. Caution is in order here because, despite profound advances
in this influential area of contemporary banking theory, one cannot dispel the
impression that organizational and institutional aspects of banking remain
underestimated or ignored. Contemporary banking studies rely on default the-
ories of the modern firm, mostly based on neo-institutional theories of the firm
(agency theory and property rights theory). Since 1970, banking theory has
evolved as a sub-discipline of financial economics wedded to conceptions of
financial market efficiency, neo-classical economics and models of dynamic
stochastic general equilibrium. Meanwhile, traditional conceptions of banking
and institutional approaches increasingly appeared anachronistic, as market-
based banking came to dominate the industry and lawmakers amidst deregula-
tion, privatizations, demutualization, disintermediation, and financialization.
With notable exceptions such as Minskyian theories of financial instability,
critical approaches in political economy, and regulation approaches, banking
studies focused on a limited set of questions about market failures, the impor-
tance of law (basically the protection of creditors) and agency theories of own-
ership and governance in joint-stock banks (ironically, just as private equity
firms and other forms of ownership grew as alternatives in response to problems
with shareholder-based governance).21

21 We thank Yuri Biondi for suggesting this focus on how alternative banks counter market
failures.

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 Alternative Banking and Theory 29

The following sections mirror the trajectory of contemporary banking theory

by first drawing on agency theory, then turning to theories of intermediation and
asymmetric information to explain the competitive advantages and systemic
importance of alternative banks. These approaches present important flaws
and make disputable theoretical assumptions. However, because they have
largely shaped debates about bank performance in the academic literature,
they provide a necessary point of departure for our analysis. Moreover, ironically
(given the bias of contemporary banking theory toward private ownership), both
agency theory and intermediation theory nonetheless provide important, if
limited, explanations of the competitive advantage of alternative banks found
in the empirical evidence discussed above. The limits of these two approaches
inform our turn to heterodox views of how firms acquire and maintain institu-
tional foundations of competitive advantage, approaches that provide both more
compelling explanations of recent empirical findings about alternative banks
and greater promise for development of alternative banking theories.

7 Alternative banking and agency theories of

shareholding and market discipline
Most comparisons of bank performance are informed by concepts and measures
from agency theory that emphasize shareholders, contractual control, and
market discipline of management. From this perspective, the efficiency of
banks depends on their ability to mitigate potential agency conflicts. As noted,
mainstream theories of the firm have remained the explicit (Fama, 1980a, 1980b)
or implicit bases of contemporary theories of banking since the 1960s.
Comparative analyses of bank shareholding structures in the 1990s (which set
the terms for current debates on government vs private banking) also made
extensive use of agency theory (Altunbaş et al., 2003). Indeed, the dichotomy
between “stakeholder-oriented” and “shareholder-oriented” banks (Coco &
Ferri, 2010) suggests the primacy of governance and shareholding issues in
this literature.
While the distinction between stakeholder and shareholder governance in
banking is not questionable per se, the following problems remain: (1) the
explicit or implicit adherence to mainstream neo-classical theories of the firm
in most discussions of the advantages of public or mutual vs private share-
holding/control; (2) the implicit assumption that shareholding and governance
are the key characteristics that distinguish alternative banks from private banks;
this ignores other critical differences emphasized herein.

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30 O. Butzbach and K. E. Mettenheim

Studies of non-profit firms help compensate for the first problem in com-
parative studies of banking. While economic thinking about non-joint-stock
forms of organization has evolved since the dismissal of mutuals as more
conducive to shirking by managers in Alchian and Demsetz (1972),22 biases
toward joint-stock ownership remain pervasive. The core ideas of agency theory
and property rights theory (often conflated in modern theories of the firm) were
set by Alchian and Demsetz (1972, 1973) and Jensen and Meckling (1976) and
developed (Fama, 1980b; Fama & Jensen, 1983a, 1983b; Hart & Moore, 1990) on
the same basic premises, especially the assumption that certain organizational
forms are better than others in reducing transaction costs. Alchian and Demsetz
saw modern firms as able to solve problems of measurement of marginal
productivity in the context of team production (1972, 1973). Given the need to
monitor the behavior of team members, but the difficulties of assessing indivi-
dual behavior (given information asymmetries and cognitive limitations) and
choosing the right monitors (and monitoring the monitor), early theorists
focused on the bearer of residual risk; the residual claimant, a.k.a. the share-
holder (Fama & Jensen, 1983a, 1983b). This is the theoretical basis for asserting
the superiority of shareholder-oriented corporate governance, leading some to
predict convergence, over time, of all organizations toward this form of owner-
ship (La Porta et al., 2002; Hansmann & Kraakman, 2000).
To the contrary, theory and evidence from research on non-profit firms
suggests that the business models of alternative banks (based on sustainable
returns for longer term horizons, stakeholder-oriented governance, and social or
public policy missions) are better able to reduce agency costs to retain compe-
titive advantages over private banks. The next two sub-sections develop this
argument in more detail.

7.1 Manager–shareholder agency conflicts

Agency conflicts arising from the separation of management from ownership

remain at the center of theories of the firm and analyses of bank governance.
Concepts such as rent-seeking and expense-preference behavior (Fama &
Jensen, 1983b; Hart & Moore, 1990) suggest that dispersion of shareholding
allow managers to pursue their own interests. Indeed, monitoring and

22 This all boils down to the absence of shareholders in mutuals, according to Alchian and
Demsetz: “In nonprofit corporations, […] the future consequences of improved management are
not capitalized into present wealth of stockholders. […] One should, therefore, find greater
shirking in nonprofit, mutually owned enterprises” (Alchian & Demsetz, 1972, p. 790).

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 Alternative Banking and Theory 31

controlling managers and designing incentives to align the interests of share-

holders and managers can be very costly. Managers may also capture free cash
flows generated by the firm. Free or uncommitted funds may lead managers to
invest in unprofitable projects (Jensen & Meckling, 1976). Cooperative banks,
government banks, and private banks all face conflicts of interests between
owners and managers. However, agency costs for alternative banks can be
said to be lower than in private, joint-stock banks. Indeed, for Hansmann
(1996), the opportunism of managers in joint-stock firms in the nineteenth
century helps explain the rapid growth of mutual forms of banking organiza-
tions in North America.
This runs counter to arguments by Rasmussen (1988) about mutual banks,
by Mayers and Smith (1994) on mutual insurance firms, and by LaPorta et al.
(2002) on government banks. Arguments favoring joint-stock ownership and
shareholder governance run as follows (Ayadi et al., 2010): (i) stakeholder-
based banks have more autonomous managers than shareholder-based banks
(so they incur higher agency costs); (ii) stakeholder-based banks cannot rely on
market mechanisms to reduce agency costs; and (iii) stakeholder-based banks
cannot reduce agency costs with the tools used by private, joint-stock companies
(such as stock options and other pay-for-performance schemes).
The question of manager autonomy at alternative banks is complex.
According to agency theory, diffuse ownership increases managerial autonomy
and weakens controls on self-interested managers.23 Mutual banks and coopera-
tive banks do indeed have more diffuse ownership because the “one member
one vote” principle impedes accumulation of voting power as in joint-stock
banks: “the [mutual] manager is freed not by the absence of concentration,
but by the absence of the threat of concentration” (Rasmussen, 1988, p. 397).
However, recent research on stakeholder governance at German local savings
banks demonstrates that corporate boards with representation of stakeholders
tend to exercise greater control over executives and managers in comparison to
joint-stock banks (Hackethal, Schmidt, & Tyrell, 2005).
From the perspective of agency theory, government savings banks and spe-
cial purpose banks can be said to have a smaller number of stakeholders with
higher stakes in the bank – typically local, regional, or national governments and
representatives from political and social forces that sit on corporate boards. This
runs counter to an axiom of property rights theory (which inspires much of the
work on agency conflicts): That public ownership is much less apt than private

23 By contrast, diffused ownership was seen by Berle as a good thing since it broadens the range
of stakeholders involved in the firm’s organization and allows firms to pursue general interest
goals as well. See Weinstein (2012). Thanks to an anonymous referee for pointing that out.

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32 O. Butzbach and K. E. Mettenheim

ownership at creating incentives for the monitoring of managers. For Shleifer

(1998, p. 135), “private ownership is the crucial source of incentives to innovate
and become efficient” while state ownership leads to “grotesque failure” given
the (supposed) utility function of politicians to maximize patronage and personal
income. Such distortions of principal–agent relations (and profit maximization in
politics and public policy) arise from presumed weak and perverse incentives in
public shareholding and regulation (Grossman & Hart, 1980; Fama & Jensen,
1983a). For Kane, “short-horizoned authorities can allow banks to snatch wealth
surreptitiously from taxpayers and simultaneously require loan officers to pass
some or all of the wealth that is snatched to a politically designated set of favored
borrowers” (Kane, 2000, p. 161). Criticism of government bank management
predominates in neo-institutional theories of corporate governance (Shleifer,
1998; Shleifer & Vishny, 1997) and the ownership rights literature (critically
appraised in Weinstein, 2012). Cornett et al. (2010) claim that state-owned banks
perform worse than privately owned banks citing Shleifer and Vishny (1997) and
Kane (2000) to assert that perverse incentives reign when state bureaucrats run
financial institutions. Dinç (2005) and Micco et al. (2007) also claim that politics
influence state-owned banks and bias lending policies. Regulators, add Barth,
Caprio, and Levine (2006), are no “angels”. One may add that regulators are not
necessarily “devils” either. The negative views of state actors so pervasive in the
neo-institutional economics literature on banking (which informs a good part of
banking studies) are wrong, for several reasons: because homo politicus is not
homo economicus; because free markets and joint-stock ownership are not neces-
sarily optimal; because reported correlations are usually spurious (aggregate data
used to condemn state banks conceal rather than reveal causes); and, as far as
emerging countries are concerned, because authoritarian governments are most
responsible for mismanagement at state banks rather than rent-seeking politi-
cians in democratic times. They further neglect central banking coordination,
supervision, and control as a mode of public policy and general interest inter-
vention with reduced political interference.
Cooperative banks and mutual savings banks lack shareholders. However,
they have members and stakeholders. Cuevas and Fischer (2006) argue that
“expense preferences” (the propensity of managers to invest in costly projects
regardless of their contribution to the firm) constitute the main source of failure
for cooperative bank managers; and the dilution of membership, they say,
aggravates this problem. Cooperative bank managers also face multiple stake-
holder constituencies (Cuevas & Fischer, 2006): members, employees, net bor-
rowers, net savers, public authorities, and political and social forces. However,
Fama and Jensen (1983a) argue that boards with outside directors may control
management – even in non-profit firms.

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 Alternative Banking and Theory 33

A third source of potential conflicts between managers, members, and

stakeholders in cooperative banks and mutual savings banks arise from the
weak incentives presumably inherent to non-private ownership (as mentioned
above in the case of government banks). Cooperative members are not the same
as private bank shareholders: their degree of control is unrelated to the size of
their equity stakes, and they cannot buy or sell equity on the market.
Cooperative bank equity is therefore different. Indeed, cooperative bank
equity can be seen as an intergenerational endowment that does not belong to
anyone (Fonteyne, 2007). From this perspective, managers of cooperative banks
can be considered as custodians of the endowment, reducing member incentives
to exert effective oversight over management which raises a series of governance
problems (Fonteyne, 2007). However, specific governance structures in coopera-
tive banks may discipline managers in a collective fashion that differ from the
individual, bottom-up incentives, and preferences that are assumed by agency
theories of corporate (and bank) governance.24
In sum, alternative banks either face fewer potential agency conflicts or manage
owner–manager agency conflicts differently but as well or better than joint-stock
banks. This counter two core assumptions in banking studies: (i) that shareholder-
oriented banks face fewer owner–manager problems and that (ii) private ownership
and market mechanisms provide the best incentives for controlling agents.
Alternative banks have developed different mechanisms to reduce owner–
manager agency conflicts through monitoring, control, and incentives. Compare
these mechanisms to those emphasized in accounts of corporate governance in
joint-stock banks. New-institutional economics suggests that joint-stock banks
rely on two key devices to lower agency costs: market discipline and contracts
inside the bank that provide incentives able to align the interests of managers
with those of shareholders. Market discipline turns on the right of shareholders
to sell their shares and organize corporate takeovers to change management.25

24 This point was kindly suggested by an anonymous reviewer.

25 Market discipline remained at the core of bank regulation in the 1990s. For instance, in the
Core Principles for Effective Banking Supervision published by the Basel Committee on Banking
Supervision (1997): “Supervisors should encourage and pursue market discipline by encoura-
ging good corporate governance and enhancing market transparency and surveillance” (p. 8).
In a similar vein: “I also believe that we ought – where we can – to skip the middlemen and go
right to our first line of defense: market discipline. By aligning market incentives with regula-
tory incentives, policies designed to harness market forces could complement bank supervision
by encouraging banks to refrain from excessive risk-taking”. “Market Discipline as a
Complement to Bank Supervision and Regulation”, Remarks by Governor Laurence H. Meyer,
Before the Conference on Reforming Bank Capital Standards, Council on Foreign Relations, New
York, June 14, 1999, www.federalreserve.gov/boardDocs/Speeches/1999/19990614.htm.

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34 O. Butzbach and K. E. Mettenheim

Moreover, in shareholder-oriented banks, value added is appropriated by exter-

nal shareholders who may demand increased dividends and share buybacks to
solve the free cash flow problem (Jensen, 1986). This is at the core of the
shareholder value maximization paradigm which has remained dominant in
corporate finance theory and practice since the 1980s (Hansmann &
Kraakman, 2000).
Alternative banks cannot rely on these market mechanisms to discipline
managers from outside the banking firm. However, it does not follow that
alternative banks are less able to discipline managers (Fonteyne, 2007). First,
Cen, Dasgupta, and Sen (2013) show how takeover threats may actually damage
the standing of private bank managers. Second, alternative banks have devel-
oped their own external monitoring and controlling devices. Third, if govern-
ment-owned banks are politically controlled (Shleifer & Vishny, 1998; Dinç,
2005), this implies that governments and other stakeholders exert more, not
less control over bank managers in comparison to shareholders of joint-stock
banks. Fourth, while Bhattacharya and Thakor (1993) emphasize the lack of
secondary markets for residual claims in non-private banks (to support their
hypothesis of greater efficiency at privately owned banks), Ayadi et al. show,
building on the work of Fama and Jensen (1983a, 1983b), that the equity held by
cooperative members is indeed redeemable on demand. Exit is thus a powerful
device to discipline managers in cooperative banks, too. It is especially strong as
cooperatives usually cannot sell new equity on capital markets to counter the
threat of exit from equity holding members. The absence of markets for coop-
erative equity makes exit from cooperatives more effective as a device for
disciplining managers.26
Cooperative banks and savings banks also rely on another powerful external
device for disciplining managers: two-tiered networks.27 The historical section
above describes how local and regional cooperative banks and savings banks
created second-tier entities for giro payments and transfers, wholesale banking,
insurance products, investment banking, and capital market operations. These
shared28 second-tier finance groups provide back-office support and specialized
subsidiaries able to offer services through independently owned and managed
local and regional banks. In the past, they supplied joint-liability and cross-

26 We thank an anonymous reviewer for this observation; in cooperatives, exit through

redemption replaces market exit.
27 This organizational structure is both a network – in a sense of a horizontal structure
composed of autonomous entities – and a two-tiered structure (with apex institutions and
specialized subsidiaries).
28 Sharing seems a form of contractual cooperation specific to alternative banks.

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 Alternative Banking and Theory 35

guarantee schemes to increase network stability.29 Most important here, how-

ever, are the monitoring and control functions fulfilled by second-tier organiza-
tions.30 Second-tier finance groups serve as apex institutions that exert pressure
to avert abuse of free cash flows, limit the ability of managers to appropriate the
patrimony of banks, and bring peer pressure to control and discipline managers
of regional and local cooperative banks (Fonteyne, 2007; Guinnane, 1997, 2001).
Cooperative networks also constitute joint-supply alliances that reduce the
uncertainties of resource procurement, a rarely considered but important poten-
tial locus of agency conflicts (Desrochers & Fischer, 2005; Cuevas & Fischer,
2006).
In sum, alternative banks rely on devices of external control and monitoring
that may discipline managers at least as effectively as the market mechanisms
central to shareholder-based governance of joint-stock banks.
What about internal devices? Joint-stock banks use contractual devices to
reduce potential agency conflicts between shareholders and managers. The
literature on corporate finance and agency theory argues that contracts may
align the interests of managers and shareholders (Jensen & Zimmerman, 1985).
From this perspective, performance compensation schemes increase the interest
of executives in the price of firm’s shares (for example, through stock options).
Fonteyne (2007) and Cuevas and Fischer (2006) note that these devices are not
available to cooperative (or public) banks. Rasmussen calls “perks” the “differ-
ence between a mutual managers compensation and his market wage”
(Rasmussen, 1988, p. 398). The use of perks in the mutual industry is also
presented as a key weakness of cooperative governance by Fama and Jensen
(1983b) and Deshmukh, Greenbaum, and Thakor (1982). From this perspective,
since perks are capped and unrelated to the individual performance of man-
agers, mutual managers have weak incentives to increase risk and profits.31
These arguments are seriously flawed. Prior to the global financial crisis of
2007–2008, evidence about the effectiveness of pay-for-performance schemes
(and, especially, stock option plans) in mitigating agency conflicts was, at best,
mixed, confirming skepticism about whether stock options would serve as
incentives to maximize shareholder value (Polo, 2007; John & Qian, 2003;
Bebchuk & Fried, 2003). Evidence from, and since, the 2007–2008 crisis is
more definitive: Top bank managers with multi-million stock option plans

29 European community regulations required local and regional German Sparkasse savings to
end cross-guarantee schemes as unfair competition by 2005.
30 German cooperative banks first developed regional institutions in the nineteenth century for
the specific purpose of performing auditing and monitoring functions (Guinnane, 1997).
31 Interestingly, risk and profits present no problem in Rasmussen’s work.

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36 O. Butzbach and K. E. Mettenheim

repeatedly endangered their banks by pursuing risky high-yield strategies

(Sorkin, 2010). In fact, executive pay schemes at large joint-stock banks has
become a key political issue in the aftermath of crisis.
It follows that the lack of these contractual devices does not impair alter-
native bank capacity to reduce agency conflicts between owners and managers.
Indeed, because such payment schemes are often very costly and may actually
induce excessive risk-taking by managers, alternative banks may be better off
without them.
Moreover, alternative banks rely on different mechanisms to discipline man-
agers. The broader social and public policy mandates of alternative banks under-
lie different corporate cultures that provide incentives for managers to perform
more responsibly and more effectively. For Fonteyne (2007), the loyalty of
employees and depositors is an important source of competitive advantage for
cooperative banks. Finally, on a cautionary note, the agency costs of delegated
management might be, as Hansmann argues, “at best of secondary importance
when determining which organizational forms are viable” (Hansmann, 1996, p. 4).

7.2 Other agency conflicts

Studies of banking reveal other potential agency conflicts besides that between
shareholders and managers, such as conflicts between shareholders and debt
holders and depositors. Asset substitution theory suggests that equity holders
have greater incentives to take risks for gains than debt holders or depositors
who bear greater losses (Leland, 1998). Alternative banks are clearly less prone
to this problem, having no (or majority) shareholders in the case of government
banks, or having holders of non-transferable equity stakes in the case of coop-
erative banks (Ayadi et al., 2010; Drake & Llewellyn, 2001). While this point is
acknowledged by Rasmussen, he diminishes its consequences for his claim that
mutual banks are less efficient than joint-stock banks by bringing up the issue of
diverse views among mutual bank depositors; such that only “independent”
managers picked by shareholders could guarantee a “cautious investment pol-
icy” (Rasmussen, 1988). But this contradicts his assertion that managers in
mutual banks are more risk-adverse than peers in joint-stock banks. And the
argument becomes self-defeating when he brings in another group, different
from bondholders and depositors: shareholders, who obviously have their own
interest and whose differences from bondholders (and bank depositors) are the
source of this agency conflict in the first place.
In sum, contrary to views of managers and depositors in contemporary
banking research, “the managers of investor-owned firms are much more willing

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 Alternative Banking and Theory 37

to speculate with their depositors’ funds than are the managers of customer-
owned and non-profit firm” (Hansmann, 1996, p. 263). The non-profit missions
of alternative banks can therefore be seen as central to mitigating opportunistic
behavior by managers.32
Agency theory also emphasizes conflicts between bank depositors and
borrowers. Indeed, theories of delegated monitoring assume that banks form
as coalitions of depositors wishing to reduce the cost of monitoring borrowers
(Diamond, 1984).33 Accordingly, borrowers and depositors have opposing inter-
ests. Depositors tend to be risk-adverse and display a high preference for
liquidity, while borrowers are risk prone and less concerned by liquidity.34
While banks cannot eliminate this agency conflict, they may reduce its costs.
Evidence and theory suggest that alternative banks incur lower costs than joint-
stock private banks from agency conflicts between depositors and borrowers.
First, cooperative banks and mutual savings banks align the interests of debtors
(depositors) and borrowers: members are both owners and depositors; while
borrowers usually must be both (Valneck, 1999). For Cuevas and Fischer
(2006), agency conflicts may arise in cooperative banks between net borrowers
(members whose borrowing exceeds personal deposits) and net lenders (the
opposite). But this conflict is much more benign than conflicts between deposi-
tors and borrowers in joint-stock banks. First, net borrowers in a cooperative
bank still have a vested interest in the sustainability of their bank over time; not
only because they are bank members,35 but also because most cooperative bank
borrowing takes place over a long period of time – it is relation-based rather
than transaction-based. Second, peer pressure from cooperative bank members
and stakeholders in the local community reduces this conflict (Ghatak, 2000).
In government savings banks and special purpose banks, investors also
retain different interests than borrowers. However, agency conflicts are attenu-
ated here because government officials (as “investors”) have different profiles
and degrees of risk aversion than private investors. For example, local and
regional government savings banks and regional and national special purpose

32 We thank an anonymous reviewer for raising this point.

33 As remarked by an anonymous reviewer, this view assumes that (i) depositors are investors
and (ii) deposits pre-exist to banking, both assumptions which are equally questionable. We
agree, but our point here is precisely to show how the existing works on alternative banks
purport to explain their feature/behavior/performance within an inappropriate conceptual
framework.
34 This asymmetry between shorter term liabilities and longer term assets also lies at the root
of the theory of banks as liquidity creators, which is discussed below in relation to risk-taking.
35 Actually, some net borrowers could gain more from refusal to pay back loans than they
could lose from the coop banks failure, which looks like the problem afflicting common goods.

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38 O. Butzbach and K. E. Mettenheim

banks usually specialize in public finance and policies such as social housing
programs. Because managers of public banks act in the public sphere in the
public interest, they have fewer incentives and fewer opportunities to betray the
interests of stakeholders. Tighter links between stakeholders and managers and
greater prerogatives of control exercised by corporate boards suggest that alter-
native banks are central for coordination that is seen as the critical characteristic
of advanced coordinated market economies and developmental states
(Mettenheim, 2010; Vitols, 2005; Hackethal et al., 2005; Hall & Soskice, 2001).
Government banks also have explicit missions to reach and serve clients such as
unbanked lower income households and small and medium enterprises that
cannot access capital markets and are often shunned by private banks. Low-
income clients and small and medium enterprises may present greater risk and,
therefore, involve higher monitoring costs; but agency conflicts and costs are
lower.
The corporate cultures of alternative banks also reduce agency conflicts
between members and managers by providing different incentives than joint-
stock banks. Social and public policy missions, and payment and career
schemes without incentives to maximize short-term profits through excessive
risk, produce distinctive management cultures and behavior at alternative
banks. As Rasmussen emphasizes, “what is important in a savings bank is not
so much altruism as stability and conservatism” and “an altruistic manager
devoted to buying the best high-yield, high-risk securities is worse than a risk-
adverse scoundrel” (1988, p. 407). Rasmussen also suggests that less complex
mixes of products and services offered by a bank reduce potential agency
conflicts between managers, stockholders, and bondholders. This applies to
the more focused missions of alternative banks.
Finally, the costs of agency conflicts between depositors and bank managers
tend to be substantially lower in alternative banks because of the higher level of
trust placed in these institutions by clients and the general public (Größl, von
Lüde, & Fleck, 2013). As Bhattacharya and Thakor note, “what makes the mutual
form the preferred structure is that it resolves the classic shareholder deposit
conflict regarding the appropriate level of risk” (1993, p. 15). This is especially
true in times of crisis. In hard times, state-owned banks are considered “safe and
better banks” (Dietrich & Wanzenried, 2011, p. 321). The greater trust of deposi-
tors and the general public in alternative banks is due to their long history, local
rooting, stakeholder-oriented governance, and corporate reputations based on
social and public policy missions. In the past, (usually government) guarantee of
small deposits at savings banks were critical for development of this trust.
Indeed, amidst crisis, depositors often shift funds to public savings banks
reinforcing both the pro-cyclical weaknesses of private banks and the counter-

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 Alternative Banking and Theory 39

cyclical liability base of government savings banks (Schclarek-Curutchet, 2014;

Mettenheim, 2010).
In sum, agency theory and studies of non-profit firms help explain several
competitive advantages of alternative banks in terms of governance and control
(see also Marsal, 2013).36 However, critics of mainstream theories of the firm
(Biondi, Canziani, & Kirat, 2007; Weinstein, 2012) rightly suggest that agency
theory is not the best approach to analyze the performance, stability, or survival
of firms, including banks. Indeed, theories that define firms as a bundle of
contracts, without any institutional or organizational existence beyond legal
form (Weinstein, 2007), may engender a self-fulfilling prophecy; managers
under the sway of this view in the US were found to focus on incentives in
their contracts in detriment to the well-being of their firms (Lazonick, 2010).37
The broader point, as Berle and Means emphasized over 80 years ago, is that the
“traditional logic of ownership” that underpins agency theory today fails to
account for the realities of shareholder involvement in large corporations
(Berle & Means, 1932; Berle, 1965; Biondi et al., 2007).
Agency theory thus falls far short of capturing the complexity of modern
economic organizations, especially banks and, most especially, alternative
banks. As Biondi argues, “rather than the so-called ‘ownership structure’ of
the firm, it is the enduring existence and financial viability of the whole firm
that is fundamental” (Biondi, 2007, p. 252). The comparative analysis of bank
performance cannot be limited to questions of ownership and control.
Governance matters. However, alternative banks differ from private banks in
three further critical ways: by their long-term horizons based on sustainable
returns and lower risk profiles, their local rooting that permits effective rela-
tional and retail banking, and their core social and public policy missions. These
characteristics of alternative banks cannot be understood within the framework
of agency theory. To better describe the institutional foundations of competitive
advantage in alternative banking, we expand our analysis in the following
sections: first to consider concepts about market failures in contemporary bank-
ing theory; then to consider heterodox theories of the firm.

36 It is ironic that, before the 2007–2008 crisis, Fonteyne (2007) highlighted the risks posed by
cooperative bank governance in terms of empire-building and appropriation risks, which were
subsequently found to be so pervasive among private banks.
37 “An integrated hierarchical reward structure ceased to regulate the pay of top executives,
who embraced wholeheartedly the ideology of maximizing shareholder value as their boards
bestowed on them ever more generous stock-option awards” (Lazonick, 2010, p. 684).

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40 O. Butzbach and K. E. Mettenheim

8 Alternative banks mitigate information

asymmetries through relationship banking
For contemporary banking theory, information asymmetries produce market
failures and explain a variety of phenomena in banking. Knowing more than
creditors, borrowers may behave opportunistically to produce moral hazard,
increase credit risk, and erode assets with non-performing loans. Lack of infor-
mation about clients or neighborhoods may, in turn, produce adverse selection
through credit rationing by loan officers (Stiglitz & Weiss, 1981). One way to
reduce information asymmetries and redress market failures is relationship
banking. Boot defines relationship banking as “the provision of financial ser-
vices by a financial intermediary that: (i) invests in obtaining customer-specific
information, often proprietary in nature, and (ii) evaluates the profitability of
these investments through multiple interactions with some customers over time
and or across products” (2000, p. 10). Relationship banking improves the
exchange of information and contracts between banks and borrowers, increases
credit supply (Petersen & Rajan, 1994), and reduces collateral requirements and
costs arising from financial distress (Hoshi, Kashyap, & Scharfstein, 1990).
Alternative banks are uniquely positioned to reap the competitive advantages
of relationship banking. Cooperative banks and savings banks are much closer to
clients (depositors and borrowers) because of their small size, local rooting and
extensive branch networks. Soft information gathered over time in proximity with
customers is a key source of competitive advantage for alternative banks over
private banks, that increasingly screen and monitor clients with poor information
from standardized aggregate databases (Ayadi et al., 2009, 2010; Fonteyne, 2007;
Cuevas & Fischer, 2006). Carnevali (2005) argues that local branch offices,
organizational networks and lending discretion provide European savings banks
with competitive advantages and make these institutions better able to provide
counter-cyclical lending to help small and medium enterprises through economic
downturns. This runs counter to Fonteyne (2007) who argues that large branch
office networks increase fixed costs just as many new products and services do
not require them (suggesting that local branch offices should lose relevance in
the near future). Theories of relationship banking suggest the contrary. The
strategy of retail-oriented alternative banks to add, rather than eliminate branch
offices, also suggests that branch office networks are a key investment to sustain
competitive advantage. Moreover, the branch office networks and relationship
banking of alternative banks are key for operating in markets (such as lending in
low-income areas) where information asymmetries discourage joint-stock banks
(McGregor, 2005; McKillop & Wilson, 2011; Mettenheim, 2010).

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 Alternative Banking and Theory 41

The proximity of alternative banks to customers reinforces relationship

banking and trust through implicit contracts with communities. For Kay (1991),
“the special value of mutuality rests on its capacity to establish and sustain
relationship contract structures.” Mutual banks and cooperative banks thereby
retain competitive advantages over private banks in terms of establishing and
maintaining trust (Kay, 2006). Trust is also sustained by by the way public banks
and cooperative banks distribute returns. While the returns of joint-stock banks
are appropriated by external shareholders, alternative banks distribute returns
to customers and members through cheaper loans or better interest rates paid on
deposits (Ayadi et al., 2010). This reinforces the inter-temporal risk smoothing
capacity of alternative banks discussed below. The social missions and corpo-
rate cultures of alternative banks also lead them to distribute significantly more
returns to social and cultural projects in local communities than the limited
strategic use of corporate social responsibility programs at private banks.38
Because members and clients of credit unions and mutual banks tend to
belong to employment groups or limited geographical areas, they are also more
homogeneous and cohesive than private bank clients (Hansmann, 1996). Credit
unions and mutual banks therefore are less likely to face adverse selection and
moral hazard and are better able to mitigate counterparty risk than private
banks (Hart & Moore, 1990). Some argue that such benefits are limited to
small-scale banks specialized in less complex operations (Akella &
Greenbaum, 1988; Rasmussen, 1988; Berlin & Mester, 1998). However, the
unique two-tiered structure of many local and regional savings banks and
cooperative banks that share wholesale banking divisions enables alternative
banks to retain the best of both worlds.
The advantages of small size, local rooting, and extensive branch network
can be maintained while shared operations help achieve economies of scale.
Fonteyne (2007) argues that cooperative banks have lost their traditional ability
to overcome opportunistic behavior by borrowers (because of the increased size
and growing distance between cooperative banks and members; and because
contracts have become more enforceable by commercial banks). We disagree.
Cooperative banks and savings banks, very early in their history, developed a
solution to this trade-off between relationship banking and economies of scale:
two-tier retail–wholesale networks. Such structures are discussed above as a
solution to several agency problems in banking; they also solve trade-offs
between relationship banking and economies of scale. Networks encourage
economies of scale, enhance bank funding opportunities, and may reduce the
volatility of performance (Ayadi et al., 2010; Cuevas & Fischer, 2006).

38 We thank an anonymous reviewer for suggesting this point.

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42 O. Butzbach and K. E. Mettenheim

Two-tiered networks may also help alternative banks avoid pitfalls of ver-
tical integration. Fama and Jensen (1983b) argue that the expense preferences of
managers increase with institutional size, but less so in networks. Alternative
bank networks also expand the range of products and services offered by local
banks, which reinforces relationship banking (Boot, 2000; Degryse & Van
Cayseele, 2000). Two-tiered networks may increase “appropriability hazards”,
basically a free-rider problem that arises from new agency conflicts within
networks (Ayadi et al., 2010; Desrochers & Fischer, 2005). However, given the
long history of wholesale operations shared by local and regional cooperative
banks and savings banks, these hazards seem to have been mitigated by net-
work integration, peer pressure, and corporate cultures as emphasized above.
In sum, cooperative banks and savings banks retain unique two-tier struc-
tures that combine independent local and regional retail banking institutions
and shared wholesale operations. This provides significant advantages in terms
of economies of scale while preserving and deepening retail relationship
banking.

9 Alternative bank funding, equity, reserves,

and patrimony
Alternative banks also fund operations, manage equity, and hold reserves and
patrimony in ways fundamentally different than joint-stock and private banks.
In Section 3, we sketched how cooperative banks and savings banks gradually
accumulated equity and reserves that serve as capital buffers, but also represent
the accumulated patrimony of the institution. Without pressures to pay divi-
dends to shareholders, cooperative banks and savings banks are freer to use
retained profits for funding. Development banks and special purpose banks may
receive equity endowments or deposits of government funds, public sector
pension funds, or public savings funds. These various sources of funding
provide alternative banks with competitive advantages over private banks and
comparative advantages for social and public policy. This counters core ideas
about financial repression. From the perspective of financial repression, the
lower cost of capital enjoyed by special purpose banks crowds out private
bank finance and distorts capital market prices. However, given the severity of
fiscal constraints on governments, state-owned banks provide a very attractive
alternative for public spending. Government banks are uniquely able to multiply
budget lines and improve the effectiveness of public policy implementation
through monitoring and control of public investments.

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 Alternative Banking and Theory 43

Because cooperative banks face lower pressures to pay dividends than joint-
stock banks, they may better mobilize and retain capital to reach more comfor-
table levels of liquidity and safer deposit-to-loan ratios and become net inter-
bank lenders (Fonteyne, 2007). Lower pay-out ratios mean that cooperative
banks (and public savings and special purpose banks) “can enjoy rapid growth
in their capital base and therefore fast organic growth” (Fonteyne, 2007, p. 47).
Altunbas et al. (2001) suggest that the superior performance of cooperative
banks and public banks over private banks can be explained by lower funding
costs due to their different deposit bases (and “less interest rate sensitive” retail
customers). In the past, cooperative banks and mutual savings banks were less
able than joint-stock banks to raise external capital through sale of new equity.
However, the specialized finance groups of savings and cooperative banking
networks access capital markets with investment grade ratings equal to or better
than the best private banks.39
In a promising line of research, Giannola (2009) argues that because
alternative banks have accumulated greater capital reserves through more cau-
tious, longer term policies to cover losses, these institutions retain a “patrimo-
nial advantage” during transition to Basel II and III accords. Before the crisis,
Fonteyne (2007) predicted that the cost of capital for banks would decrease to
the point of becoming irrelevant as part of the total cost of providing retail
financial services (and, therefore, as a factor of competitive advantage). To the
contrary, the extremely high costs of re-capitalizing (mostly private) banks
across the world since the 2007 crisis, either as regulatory requirement or as
prudential strategy, suggest that access capital at low cost remains a funda-
mental source of competitive advantage for alternative banks.
In comparison, profit maximization imperatives at private banks set power-
ful incentives against the widely acknowledged need to reduce leverage and
hold more secure levels of reserves against risk. Capitalization increases the
denominator upon which bank returns on shareholder equity (RoE) are calcu-
lated. Although the object of reforms and good practice, deleveraging and
maintaining safer levels of reserves reduces profits that are so essential for
managers and shareholders of joint-stock banks. Without such pressures to
maximize profits, managers of alternative banks are able to continue a tradition

39 One should however cite an important caveat here: in several countries over the past decade
or so, large savings and cooperative banks have been able and willing to list specialized
subsidiaries and funding instruments (with a varying degree of success: see the fate of
Natixis in France).

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44 O. Butzbach and K. E. Mettenheim

of seeing bank capital as patrimony and hold safer levels of reserves against
risk.40
In sum, staggering costs arose from the excessive leverage and errors of risk
management at private banks that relied on financial market efficiency. The
different view of capital reserve management at alternative banks – as patri-
mony and institutional endowment that require prudent risk management to
sustain corporate missions of social and public policy – therefore provide
promising grounds for alternative banking theory.

10 The sustainable business models

of alternative banks
Recent studies also underestimate how the business models of alternative banks
may provide more sustainable credit relationships over time.41 Stakeholder-
oriented governance, non-profit missions, social mandates, independent local

40 Essars (1896, p. 169) noted: “The Banks of Naples and of Sicily have a capital that they style
‘patrimony’; that is, the property of nobody. It is a unique fact in the world’s economy that there
exist two establishments which play an important part in the country which they serve, and yet
are res nullius.” He reported “patrimony” as follows in balance sheets for Italian cooperative
banks:

Assets, million lire

Cash on hand 18.5

Loans, discounts, and advances 269.2
Public bonds and industrial securities 139.5
Miscellaneous 293.4
Liabilities, million lire
Patrimony (capital and reserve) 118.2
Deposits of all kinds 357.7
Miscellaneous 238.3

41 Hart and Moore (1998) argue that institutions maximizing consumer surplus (and not profit),
such as cooperatives, will distribute this surplus to customers through price subsidies (interest
rate subsidies in the case of cooperative financial institutions). This may distort decisions and
lead to inefficient outcomes. Canning et al. (2003), however, suggest that credit rationing might
be a more optimal solution for distribution of consumer surpluses. In discussing the optimizing
decisions of not-for-profit financial institutions, Canning et al. (2003) mention the possibility
that alternative banks might have an advantage in “achieving economically efficient outcomes.”
In fact, they attribute this to market failures and monopoly power in general.

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 Alternative Banking and Theory 45

retail operations, and branch office networks embedded in communities create a

unique set of incentives and constraints that shape alternative bank governance
and performance. A loyal retail base and high level of public trust also support
more sustainable business models. These characteristics of alternative banks
generate greater stability in terms of membership on corporate boards and in
executive and managerial positions. This, in turn, reinforces longer term strate-
gies and more stable earnings (Bongini & Ferri, 2008). The aversion of alter-
native banks to short-term profit maximization contributes to better long-term
performance. According to Iannota et al. (2007), risk aversion produces higher
loan quality on alternative bank books.
Alternative banks also tend to concentrate activities in more traditional
areas of banking. This also produces more stable sources of revenue; and
lower revenue diversification helps increase systemic stability (as discussed in
Section 5). In fact, lower revenue diversification “more than offsets [alternative
bank] lower profitability and capitalization” (Hesse & Čihák, 2007). In addition,
increased stability reduces losses from credit risk, which may explain findings of
greater cost-efficiency in alternative banks (Gurtner, Jaeger, & Ory, 2002, for
French cooperative banks). Lower income diversification also helps explain
alternative bank performance in risk management.
In recent decades, banks have diversified away from traditional banking
(collecting deposits and making loans) on both sides of the balance sheet. On
the liability side, diversification and imperatives of expansion have made private
banks much more reliant on external funding sources. Contemporary banking
theory asserts that “deposit financing makes banks vulnerable to runs”
(Bhattacharya & Thakor, 1993). However, the 2007–2008 crisis surely suggests
that external wholesale funding (on capital markets and through money market
funds) may increase instability (Hardie & Howarth, 2013a; Huang & Ratnovksi,
2011).
On the asset side, contemporary banking theory also expected markets
to reduce risk: “both theory and evidence support the expectation that risks
should be reduced rather than increased should banks be permitted to engage in
securities, insurance and other services” (Benston, 1994). This view has also lost
credibility since the 2008 banking crisis. De Jonghe shows that in a study of a
sample of European banks: “the shift to non-traditional banking activities
increases banks’ tail betas and thus reduces banking system stability because
interest income is less risky than all other revenue streams” (2010, p. 26).
There is also evidence that increased reliance on fee-based income leads to
higher revenue volatility – so that income diversification actually increases,
rather than decreases risk (DeYoung & Roland, 2001; Stiroh, 2004; De Jonghe,
2010). DeYoung and Roland, in particular, find that for US commercial banks, an

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46 O. Butzbach and K. E. Mettenheim

increase in product mix (i.e. banks shifting to non-interest bearing activities) has
led to higher revenue volatility, only partly compensated for by a higher level of
revenues (as risk premium), and compounded by the potentially large losses
incurred as a consequence of excessive risk-taking. Recent empirical evidence
for European small banks shows similar results, i.e. that income diversification
increases risk (Mercieca, Schaeck, & Wolfe, 2007). Moreover, De Jonghe (2010)
finds that among European banks listed on stock markets, income
diversification increases systemic bank risk; downturns in bank stock appear
linked to downturns in bank indexes. Stiroh (2004) finds that diversification to
non-interest income is related to lower profits and higher risks in US banking.42
So it can be argued that one of the reasons for greater stability and better
overall performance of alternative banks is their lower revenue diversification,
which is the direct outcome of their different models of governance and business
and, perhaps, their smaller average size (except for development banks). This
also explains why many alternative banks resisted the “originate-to-distribute”
model (now associated with serious pitfalls) and retained instead traditional
“originate-to-hold” models. Profit-maximizing private banks that originate loans
to sell them on secondary markets tend to confront serious problems of adverse
selection and moral hazard (Berndt & Gupta, 2009; Wray, 2013; Boyer, 2013).
Berndt and Gupta find that banks actively engaged in loan selling on secondary
markets underperform their peers by 9% a year as measured by risk-adjusted
abnormal returns, concluding that the originate-to-distribute model might not be
socially desirable. This is hard to reconcile with Duffee´s claim that “in equili-
brium, banks with private information cannot systematically take advantage of
outside investors” (2009). Stakeholder-governed banks, which have a higher
propensity to retain the originate-to-hold model, have also been found to sustain
more stable earnings (Coco & Ferri, 2010).

11 Alternative banks help smooth

inter-temporal risk
Allen and Gale (1997) argue that a key advantage of banks over capital markets
is their ability to smooth inter-temporal risk. Banks are able to accumulate
capital in good times and use it in bad times. As Ayadi et al. point out,
“Creating and unlocking reserves is a specific technique of risk management”

42 By contrast, Chiorazzo, Milani, and Salvini (2008) find a positive relationship between
increased reliance on non-interest income and risk-adjusted returns for small Italian banks.

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 Alternative Banking and Theory 47

(2010, p. 108). This extends the liquidity creation thesis (Diamond & Rajan,
2000), according to which access to refinancing at low cost and the ability of
banks to enforce repayment or liquidate bad loans are key determinants of the
liquidity creation function of banks. This is the theoretical basis for our claim
that greater client confidence and trust in alternative banks provide a competi-
tive advantage over private banks. While clients tend to withdraw deposits from
private banks during crises, deposits often increase at alternative banks during
difficult times. This reinforces the capacity of alternative banks to provide
counter-cyclical lending. Alternative banks are therefore better able to perform
this critical function of inter-temporal risk smoothing (Ayadi et al., 2010).
This ability can be explained by several factors. First, as mentioned, alternative
banks retain greater trust and confidence from depositors because of their history,
more stable governance, distinctive social mandates, and economic organization
(prudent management, non-profit capital structure, and use). Second-tier organiza-
tions also strengthen trust, for instance, through cross-guarantee schemes (Coco &
Ferri, 2010), although most of these agreements were dropped by 2005 under
pressure from European Community competition rulings. Nonetheless, alternative
banks still appear able to accumulate capital more quickly because they are not
expected to distribute dividends to members – especially in hard times. In a related
argument, Berlin and Mester (1998) show that rate-insensitive core deposits allow for
inter-temporal smoothing in lending rates.
Secondly, alternative bank equity is different from joint-stock bank equity, in
that it does not belong to the “current cohort of members” (Ayadi et al., 2010).
Indeed it can be viewed as an “owner-less intergenerational endowment that is
available for use by current members, under the implicit or explicit understanding
that they will grow it further and pass it on to the next generation of members”
(Fonteyne, 2007, p. 4). In addition, alternative banks are under less pressure to
mark these endowments on the market – precisely the kind of pressure that
capital markets put on joint-stock banks (Allen & Gale, 1997), in line with the
free cash flow problem evoked earlier. Indeed, as pointed out in Ayadi et al.
(2009), joint-stock banks have incentives to disclose and distribute their reserves
in good times since it is financially profitable for the firm even though it is not
socially desirable; by contrast, public banks, savings banks, or cooperative banks
lack incentive to distribute reserves during upswings in capital markets.
Thirdly, inter-temporal risk smoothing is also linked to relationship bank-
ing. As Boot (2000) notes, the durability of bank–borrower relationships posi-
tively affects credit supply, especially for new firms or borrowers without credit
history. Indeed, losses incurred by banks at the outset of banking relationships,
which constitute a form of credit subsidy (Petersen & Rajan, 1994), are recouped
over time as relationships unfold through better soft information and trust.

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48 O. Butzbach and K. E. Mettenheim

12 Conclusions
This article explains an anomaly for contemporary banking theory and neo-
liberal policy designs: the unexpected realization of competitive advantages by
alternative banks. Often seen as anachronisms amidst pro-market reforms since
the 1980s, alternative banking groups have nonetheless performed well since
liberalization, deregulation, privatizations, demutualization, adoption of new
technologies, and the 2007–2008 global financial crisis. Despite biases toward
private ownership, market efficiency, and money center banking, concepts and
theories from banking theory nonetheless help explain, at least in part, the
performance of cooperative banks, regional and local government savings
banks, and state-owned special purpose or development banks. However, a
broader and less biased view provided by heterodox theories of the firm and
institutional foundations of competitive advantage is required to more ade-
quately explain how business models of alternative banks based on sustainable
returns, stakeholder governance, and social and public policy missions pro-
duced performance equal to or better than private banks.
This implies that banking studies need to go beyond standard approaches in
financial economics that define banks as profit-maximizing firms acting as
financial intermediaries between client-investors and capital markets.
Although they may indicate several sources of competitive advantage unique
to alternative banks, neo-institutional economic theories of the firm such as
property rights theory and agency theory (and empirical research deeply biased
against non-profit firms) fail to capture how alternative banks work. We there-
fore expand the scope of inquiry and develop a more comprehensive framework
to explore multiple facets of alternative banks as social and economic entities.43
Drawing on various strands of banking theory, past work on non-profit
firms, and recent heterodox theories of the institutional foundations of compe-
titive advantage, we provide a more complete explanation for the emergence,
evolution, and persistence of alternative banks. This framework suggests that
(a) all banks serve a much broader range of stakeholders than shareholders
alone; (b) accordingly, banks, regardless of their core mission (profit maximiza-
tion or non-profit) and governance structure (shareholder- or stakeholder-
oriented), serve a much broader set of purposes than supposed in banking
theory and empirical studies in the comparative political economy of banking;
(c) key features of modern banking (such as relationship lending) require links

43 As Biondi argues, “the interaction of the parts is not sufficient to understand the durable
existence and functioning of the firm-entity” (2007, p. 257).

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 Alternative Banking and Theory 49

and networks in economic, social, and political settings; (d) bank involvement
in inter-temporal dynamics (especially smoothing inter-temporal risk) places the
durability and stability of their operations at the heart of their business.
These four characteristics of banking help us explaining the apparent
anomaly of successful alternative banking groups; they also suggest the need
for new approaches in banking theory. In terms similar to the re-discovery and
re-interpretation of heterodox traditions in theories of the firm that improved
understanding the firm as an entity (Biondi et al., 2007), we conclude that
institutional theories of banking are needed to explain bank behavior and
performance as embedded in the social, political, cultural, and economic reali-
ties that determine competitive advantage in the many markets and spheres in
which banks allocate resources.
Theories of banks as institutions differ fundamentally from theories of banks
as shareholder-oriented firms. Contemporary banking theory defines banks as
profit-maximizing, shareholder-owned firms that manufacture assets on capital
markets. From this perspective, banks are financial intermediaries run by execu-
tives in the interest of shareholders; market-based banking allows banks to
reduce capital reserves and leverage positions through Value at Risk (VaR) or
other quantitative strategies that rely on efficient capital markets to manage risk
and manufacture assets to maximize profits.
In contrast, an institutional theory of banking defines banks as deposit-
taking and loan-making institutions that are run by corporate boards with
stakeholder representation toward the realization of social, economic, and pub-
lic policy missions. This requires balancing assets and liabilities and the use of
relationship banking and soft information acquired over time to ensure that

Table 11: Theories of banks as shareholder-oriented firms vs theories of banks as institutions

Banks as

Shareholder-oriented firms Social and economic institutions

Governance Shareholder Stakeholder

Mission Profit maximization Sustainable returns for institutional
missions
Business model Manufacture assets and increase Balance assets and liabilities
liabilities
Strategy Maximize leverage Moderate leverage
Risk management VaR or marked-based risk Relationship banking and soft
management information
Theoretical Capital market efficiency Uncertainty and social institutions
underpinning

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50 O. Butzbach and K. E. Mettenheim

investments amidst uncertainty succeed, produce sustainable returns, and con-

tribute to social and public policy goals.
An institutional approach to banking requires different measures of
bank performance. Standard measures used to compare the performance of
private banks and alternative banks suffer from biases toward the former and
implicitly or explicitly imply that banks exist as a result of market failure.
Banks, as institutions, do more than simply intermediate between citizen-
consumers and capital markets to generate market value for shareholders. It
follows that it makes more sense to gauge bank performance on bases other
than simple metrics of cost-efficiency, profitability, asset liquidity, and
capital reserves held as market positions. In fact, these measures are also
biased because they ignore the (often equally large) share of private bank
assets that are generated and held off-balance-sheets with dubious market
values, such as synthetic derivatives, repos, and other shadow banking
activities.
Theories of banks as shareholder-oriented firms and theories of banks as
institutions share many concerns that provide rich research agendas. Themes
such as credit rationing, capital drain, bank diversity, systemic stability, bank
performance in phases of the business cycle, resilience, and inter-temporal
maturity transformation provide promising areas to use heterodox theories of
the firm and institutional foundations of competitive advantage to develop
institutional banking theory. The high cost of crisis suggests new ideas are
urgently needed to counter the biases of banking studies toward private,
market-based banking, the narrow focus of mainstream theories of the firm,
and the received faith in capital market efficiency as grounds for market-based
reforms and business models that see banks as intermediaries in efficient
capital markets. Allen and Gale (2000) worried that liberalization of the bank-
ing industry risked destroying traditional social and state banking groups that
had grown organically over long periods of time. A considerable number of
alternative banks have indeed succumbed to privatizations and demutualiza-
tion, or abandoned traditions in favor of business models taken from private
banks. However, substantial evidence has emerged from recent research that
many alternative banking groups have maintained their distinctive institutional
makeup to realize competitive advantages over private banks. This provides a
more prospective agenda than Allen and Gale feared 14 years ago: alternative
banks provide a unique opportunity to develop alternative, institutional the-
ories of banking.

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 Appendices
Table 12: German bank balance sheet total assets, billion euros at historical values, 1950–2010

Private banks Savings banks Coop banks Government banks Special purpose federal Lander

Big Regional Foreign Regional National Mortgage BandL Assoc

1950 3.904 2.513 4.103 0.746 1.348 1.163 2.281 2.307

1960 14.650 13.744 28.703 3.628 7.238 22.060 13.323 17.446
1970 42.726 44.559 6.159 95.922 16.042 32.233 56.975 35.257 65.055
1980 115.207 127.593 22.763 265.340 51.510 131.337 163.056 76.420 195.575
1990 239.568 409.801 39.007 552.589 110.790 302.615 312.510 255.426 389.486
2000 969.783 613.223 121.407 953.920 227.383 533.621 891.816 153.632 460.829 1,222.704
2010 2,082.896 735.097 203.673 1,082.870 262.500 705.044 719.525 198.908 898.227 1,463.536

Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/statistics.html?nsc=true. Accessed on 10 February 2014.

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51

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 52

Table 13: Deposits by type of bank, Germany 1950–2010, billion euros at historical values

Private banks Savings banks Coop banks Government banks Special purpose Lander
federal
Big Regional Foreign Regional National Mortgage BandL Assoc

1950 1.280 0.823 – 0.541 0.609 0.346 0.18 0.637 1.000

1960 2.776 3.352 – 2.069 2.711 0,691 1.448 2.024 7.153
1970 8.785 14.812 5.026 7.643 12.686 3.253 5.678 9.126 24.310
O. Butzbach and K. E. Mettenheim

1980 30.483 42.218 18.941 29.307 39.698 17.639 26.549 27.276 59.245
1990 63.929 187.833 32.854 76.114 88.660 34.958 35.129 87.725 142.183
2000 369.685 188.773 83.132 234.344 129.214 80.978 105.536 28.454 116.042 439.058
2010 456.900 150.252 133.361 188.377 130.190 99.632 225.684 30.293 158.409 406.481

Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/statistics.html?nsc=true. Accessed on 10 February 2014.

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 Alternative Banking and Theory 53

Table 14: Interest spread by type of German Bank, 1970–2010, in %

Year Private banks Savings Coop banks Govt banks

banks
Big Regional National Regional Sp. purpose Lander

1970 2.67 2.04 2.75 0.84 3.52 0.99 0.69

1980 2.11 1.65 2.93 0.73 3.29 0.68 0.58
1990 2.32 1.81 2.67 0.66 2.95 0.7 0.61
2000 0.94 1.72 2.33 0.78 2.45 0.45 0.56
2010 0.95 1.69 2.20 0.48 2.33 0.44 0.68

Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/

statistics.html?nsc=true. Accessed on 10 February 2014.

Table 15: Interest income as % balance sheet by type of German Bank, 1968–2011

Year Private banks Savings banks Coop banks Government special

purpose banks

Big Regional National Regional Federal Lander

1970 7.2 7.82 7.17 6.5 7.88 5.08 6.38

1980 8.55 8.5 7.65 7.82 8.24 6.53 7.25
1990 7.75 7.68 7.23 7.92 7.56 6.46 7.33
2000 5.24 5.58 5.72 5.04 5.69 5.81 5.63
2010 2.19 3.74 4.02 2.27 4.03 4.47 3.21

Source: Deutsche Bundesbank, available on www.bundesbank.de/Navigation/EN/Statistics/

statistics.html?nsc=true. Accessed on 10 February 2014.

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 Table 16: A synthesis of empirical analyses of alternative bank performance
54

Study Main focus Countries Period of Units of Method Independent Dependent Main findings Data sources
covered observation observation variables variables

Ayadi et al. Cooperative 7 European 2000–2008 Sample of Pooled OLS Bank type Measures of Cooperative banks Bankscope;
(2010) and countries banks (total regression efficiency, more profitable and in national
commercial no. of 29,978 and a fixed profitability and many cases more cost- cooperative
banks observations) effect risk: RoA, RoE, efficient, and more associations
Panel cost–income stable
regression ratio, earnings
stability, regional
growth, market
power
Cornett State-owned 16 East Asian 1989–2004 Sample of t-Test; Bank Several Compared to state- Bankscope;
et al. banks and countries 456 banks (of pooled cross- ownership performance owned banks, privately additional
O. Butzbach and K. E. Mettenheim

(2010) privately which 142 sectional and measures: ROA owned banks are more sources for
owned government- time-series and a modified profitable and better ownership data
banks owned) regressions ROA (pre-tax capitalized, have lower
with error cash flows/book- percentages of non-
terms value total performing loans
Clustered at assets), capital
the firm level ratios, NPLs
Ayadi et al. Savings and 5 European 1996–2006 Sample of Stochastic Bank type Measures of No significant Bankscope;
(2009) commercial countries banks (19,139 frontier efficiency, differences between national
banks observations) based on a profitability and savings and savings banks

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translog cost risk: RoA, RoE, commercial banks in associations
function cost–income terms of efficiency and
ratio, earnings profitability. Slight
stability, regional advantages in terms of

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growth, market earnings stability
power

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 Beck et al. Savings and Germany 1995–2007 Sample of Regressions; Bank type z-score, Savings banks more Deutsche
(2009) commercial 3,810 banks panel logit likelihood stable than commercial Bundesbank
banks model distress, non- banks
performing loan
ratio
Bongini Cooperative Italy 1995–1998 Sample of 211 OLS Bank type; Profit volatility Cooperative banks Bankscope
and Ferri and banks regressions governance (standard show lower profit
(2008) commercial (board deviation of RoA) volatility than
banks stability) and commercial banks
income
diversification
Garcia- Savings and Spain 1993–2000 Sample of 127 Dynamic Bank type Earnings stability Spanish savings banks Savings banks
Marco and commercial banks (total panel data (z-score) and less risky than association,
Robles- banks no. of 1,030 solvency ratio commercial banks Spanish
Fernandez observations) Securities and
(2008) Exchange
Commission
and the Private
Banking
Association
Cihak and Cooperative 29 OECD 1994–2004 Sample of Regression; Bank type Earnings stability Cooperative banks are Bankscope
Hesse and countries banks (16,577 panel model (z-score) more stable than

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(2007) commercial observations) commercial ones
banks
Alternative Banking and Theory

(continued )

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55

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 56

Table 16: (Continued )

Study Main focus Countries Period of Units of Method Independent Dependent Main findings Data sources
covered observation observation variables variables

Iannotta et Mutual and 15 European 1999–2004 Sample of 181 OLS Bank Cost-efficiency, Cooperative and Bankscope
al. (2007) government- countries large banks regression ownership profitability, government-owned
owned and earnings stability banks slightly more
commercial (asset quality cost-efficient, less
banks and z-score) profitable than
commercial banks;
mutual banks less
risky, government-
owned banks riskier
O. Butzbach and K. E. Mettenheim

Carbó Savings 1992–2001 Sample of 77

Valverde, banks commercial
Kane, and and savings
Rodriguez banks
(2008)
Chakravrty Savings and Germany 1999 516 banks Stochastic Bank Operating profit Commercial banks less Bankscope
and commercial frontier ownership efficiency profit efficient than
Williams banks non-profit banks
(2006)
Crespi et Savings Spain 1986–2000 Sample of Multivariate Bank RoA Savings banks more Savings Banks

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al. (2004) banks banks (total regression ownership profitable than association
no. of and commercial banks and private
observations: governance banks
2,105) mechanisms association

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 Altunbas et Savings, 15 European 1990–2000 Sample of Stochastic Bank Cost and profit Commercial banks less Bankscope
al. (2003) cooperative, countries þ the banks (total frontier and ownership efficiency cost-efficient but more
and US no. of 25,841 translog profit efficient than
commercial observations) function savings and
banks cooperatives
Carbó Savings 12 European 1989–1996 Sample of Stochastic Bank size and Cost-efficiencies Smaller savings banks Bankscope
Valverde, banks countries banks (total cost frontier country are more efficient than
Gardener, no. of large ones
and observations:
Williams 4,083
(2002)
Salas and Savings and Spain 1983–1997 1,381 bank Regression; Bank type Risk (measured No significant Central bank
Saurina commercial observations panel data as the ratio of difference between
(2002) banks analysis problem loans) commercial and
savings banks
La Porta et Government- 92 countries 1960–1995 Country OLS Country-wide Financial Government ownership Various:
al. (2002) owned sample regressions degree of development and of banks slows down Banker’s
banks government economic growth financial development Almanach,
ownership of and growth Thomson Bank
banks Directory,
World Bank
Altunbas et Cooperative Germany 1989–1996 7,539 bank- Stochastic Bank Cost-efficiency Slight cost and profit Bankscope
al. (2001) and savings level frontier ownership advantages for non-
banks observations profit banks
Valneck Building United 1983–1993 Sample of 17 Parametric Bank RoA, adjusted Mutual building Bankscope

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(1999) societies Kingdom building models ownership RoA, other societies outperform
Alternative Banking and Theory

and societies and type earnings joint-stock retail banks

commercial 7 banks measures
banks

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(continued )
57

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 58

Table 16: (Continued )

Study Main focus Countries Period of Units of Method Independent Dependent Main findings Data sources
covered observation observation variables variables

Cole and Thrift United States 1983–1995 Sample of 94 Ownership Stock Demutualized thrifts
Mehran institutions institutions change performance perform better than
(1998) (annual stock thrifts
returns)
Esty (1997) Savings and United States 1982–1988 Sample of Parametric Bank type Risk-taking Stock thrifts show Federal
loans and 2,515 SandLs and non- greater risk-taking than agency’s
O. Butzbach and K. E. Mettenheim

commercial parametric mutual thrifts annual reports

banks methods
Cebenoyan Savings and Atlanta, United 1988 Sample of 559 Stochastic Bank type
et al. (1993) loans States SandLs cost frontier
Mester Savings and United States 1991 Sample of Stochastic Bank Cost-efficiency Joint-stock SandLs are
(1993) loans 10,571 SandLs frontier; ownership more efficient than
parametric mutual SandLs
cost function

Source: Butzbach and Mettenheim (2014, pp. 36–40).

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 Alternative Banking and Theory 59

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