With ineffective market discipline of stand-alone activities conglomeration would further undermine market discipline, but may nevertheless be beneficial. In particular, when rents are not too high the diversification benefits of conglomeration may dominate the negative incentive effects. A more competitive environment therefore may induce conglomeration. Introducing internal cost of allocation schemes may create 'internal' market discipline that complements the weak external market discipline of the conglomerate. Policy makers in many countries debate the extent of powers that commercial banks should be allowed.
Economists sometimes argue that there is no reason to debate the issue on efficiency grounds.
Commercial banks should be allowed all powers, and competition will ensure they will adopt only those ones that they can perform competently. In other words, so long as competition is not artificially restricted, efficient institutions will emerge. This paper shows that unrestricted competition does not necessarily lead to efficient institutions if the markets in which institutions compete are not naturally competitive. Therefore, the debate on what powers banks should have is relevant even from an efficiency point of view. More evidence is needed to inform policy makers, especially in developing countries.