Relationship Banking is a strategy used by banks to enhance their profitability. They accomplish this by cross-selling financial products and services to strengthen their relationships with customers and increase customer loyalty. Relationship banking involves offering customers a broad array of financial products and services that go beyond simple checking and savings accounts.
In addition
to these
two basic
products, relationship-banking products may
include
certificates
of deposit, safe deposit boxes, insurance,
investments,
credit cards,
loans
and business services
(e.g., credit card processing). They may also include specialized financial products designed for specific demographics, such as students, seniors or the wealthy.
Merits and Demerits of Relationship Banking
Relationship
banking can add value
through its contractual
features that,
though mostly implicit,
facilitate long-term relations (Ferri, Kang and Kim, 2001; Hoshi and Patrick, 2000).5
Monitoring costs are economized through reciprocal delegated monitoring among credit suppliers, virtually making the loans of a relationship bank subordinate to other banks’ loans and public debt.
Inefficient closures of distressed but economically solvent firms are prevented, and cases of corporat e financial distress are effectively resolved.
Liquidity constraints are mitigated
and business risks shared between
a relationship bank and its corporate clients over their cycles of cash flows and profits, since loans are made from a long
-term perspective.
However, relationship
banking is
not without
potential
perils,
which
must be
minimized by sound business judgment and discipline (Ferri, Kang and Kim, 2001; Hoshi and Patrick, 2000).
Investment efficiency can be low due to soft-budget constraints. That is, given the good chance of loan renegotiations with their banks, firms with a relationship bank may have weaker ex ante incentives
to boost their effort (Bolton and Scharfstein, 1996).
A relationship bank might extract rents from its clients in the form of higher lending rates and others
because they are informationally captured and have difficulties turning to other financing sources.
Firms with a relationship bank may take too few risks in their businesses, as the bank will discourage investment projects with both high return and high risk.
The system of relationship banking is often supported by heavy government regulation of the
financial
markets, which delays capital market (including the market for corporate control) development and results in inefficiency in the banking sector.