Expertise and Specialization in Bank Trading

Abstract

Firms must choose which activities to pursue and which to leave to competitors, but empirical examination of the determinants of organizational scope remains limited by measurement challenges. Using novel supervisory data on individual trading desks at U.S. banks, we find that, distinct from prevailing theories of diversification driving scope, banks concentrate information-processing capacity in clusters of related activities. We document that banks specialize in activity clusters where they earn higher profits and have more precise assessment models. Examining reallocations, we find that specialized labor flows to expert banks, particularly in response to changes in risk limits tied to forecasted demand. Finally, banks contract non-core activities as they approach constraints. Our results highlight the importance of labor and organizational frictions for trading.