Banking and Trading

46 Pages Posted: 5 Sep 2012 Last revised: 13 Feb 2014

See all articles by Arnoud W. A. Boot

Arnoud W. A. Boot

University of Amsterdam - Amsterdam Business School; Centre for Economic Policy Research (CEPR); Tinbergen Institute

Lev Ratnovski

International Monetary Fund; European Central Bank, Financial Research Division

Multiple version iconThere are 3 versions of this paper

Date Written: April 30, 2013


We study the interaction between relationship banking and short-term, scalable arm's length finance which we call trading. Relationship banking is not scalable, has high franchise value, is long-term oriented and low risk. Trading is transaction-based: scalable, with lower margins (capital constrained), short-term, and more prone to risk shifting. When a bank engages in trading, it can use its franchise value to expand the scale of trading. However there are two inefficiencies. We show that a bank may allocate too much capital to trading ex post, compromising the ability to build relationships ex ante. And a bank may use trading for risk shifting. Financial innovation and the deepening of financial markets have pushed much of arm's length finance into the realm of trading by improving the marketability of assets. While combining relationship banking and trading offers some benefits at a low scale of trading, the unbridled growth of trading opportunities is distortive. The analysis offers insights into bank business models and helps assess recent initiatives aimed at structural reforms in banking.

Suggested Citation

Boot, Arnoud W. A. and Ratnovski, Lev and Ratnovski, Lev, Banking and Trading (April 30, 2013). Amsterdam Center for Law & Economics, Available at SSRN: or

Arnoud W. A. Boot

University of Amsterdam - Amsterdam Business School ( email )

Roetersstraat 11
Amsterdam, 1018 WB
+31 20 525 4162 (Phone)
+31 20 525 5318 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

United Kingdom

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA

Lev Ratnovski (Contact Author)

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States


European Central Bank, Financial Research Division


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