Applied Strategey - Academic - How is Bank Performance Affected by Functional Distance?

“How is Bank Performance Affected by Functional Distance” is an article whose purpose is to confirm the presence of a relationship between the territory and the bank.  Its main goal was to verify the effect of functional distance and bank performance.  The article defines functional distance as “the distance between a local system and a bank. It considers all the banks which, although physically closer to customers of a certain area, have their own decision-making and policy center away from it (Alessandrini, Croci and Zazzaro, 2005).”  To support the idea above, several variables were tested to see the effects on performance.  Such variables include bank size, intensity of labor factor, and bank type to name a few.  This study was tested over a period ranging from 2005 to 2008.  The sample size was close to 3,000 Italian banks.  Furthermore, a multivariate regression model was used where the dependent variable was Performance and many independent variables. The results were charted in many different charts. 

 This area of study is important because we have seen many small and large banks close in recent years.  Many have also declared bankruptcy.  To study the effects of several different variables and to see and understand how it affects a bank is important because individuals like me and others need banks for financing needs. It is not to our benefit to see banks close down. Moreover, it becomes an inconvenience for us as individuals.

 The type of research used in this study is hypothesis testing.  The hypothesis is to confirm the effect of functional distance and bank performance. The actual sample size consisted of 2,702 observations with each observation representing 680 banks for each year.  The sample size represented 85.6% of the Italian banking system.  Three main sources were used in this study. They are ABI Banking Data, Bank of Italy for data on geographical location, and ISTAT (The National Institute of Statistics).  Four hypotheses were tested. They are as follows:

H1: There is a strong association between functional distance and bank performance.

H2: There is a significant negative association between bank performance and foreign control of banks.

H3: The association between bank performance and intensity of labor is strong.

H4: There is a negative relation between bank performance and typology of bank (joint stock banks, local cooperative banks, national cooperative banks).

Data collected support the four hypotheses.  I will go over H1.  The article states the following: “According to the results, bank performance is affected in a negative way by increasing distance between the “thinking head” of the bank and its branches. The inevitable costs of monitoring, the less and worse capacity for the screening if distant customers, the difficulty of transferring efficiency to branches further way, and informational disadvantage, certainly have a negative impact on bank performance.”  In different words, the article is trying to state that the more distant banks are from each other, the higher the costs to maintain that bank. Furthermore, it is difficult to screen customers for their credibility.  We do live in a nation that is full of fraud and sometimes fraud is hard to detect. I, personally, believe that small banks are better and work more efficiently than large banks. I say this from personal experience and because I am a small business owner that had bad experiences with large banks.   At the same time, large banks are probably great for big companies that provide all the necessary documents to pass creditworthiness.

For practicing managers, I would have to say that this is a topic that is really important. I did not go over every variable that was analyzed in this study but they all seemed very important to me. If a manager is in the banking business, I do believe that he/she will need to review studies like this especially if it is a large bank that has several branches worldwide. The article discusses the importance of ROA (return on assets) and the effect of functional distance on many different levels. All things need to be considered especially in the banking business.  Money is the most liquid asset available to all of us and as a manager; he/she needs to make sure that a bank is not put into a bad financial position.  It is the responsibility of the manager to communicate well with upper management if he/she feels that things are not good.

Giuseppe Torluccio and Matteo Cotugno  and  Stefania Strizzi, “How is Bank Performance Affected by Functional Distance?”.  European Journal of Economic, Finance and Administrative Sciences; Oct 2011, Issue 39, p79-93, 15p, 4 charts

Alessandrini, P., Croci, M., Zazzaro, A., 2005. “The geography of banking power: the role of functional distance”, BNL Quarterly Review 235, pp. 129-167.