Intra-Bank Electronic Capital Markets andHierarchical Coordination: Searching for theOptimal Mixed Mode Banking Operation

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