On the Importance of Retail Banking Relationships
FDIC Center for Financial Research Working Paper No. 2007-06
41 Pages Posted: 2 Jul 2007
Date Written: May 2007
While the importance of bank-firm relationships is well documented in the banking literature, there is relatively little research on the importance of retail banking relationships. In this paper we collect proprietary data from multiple sources to analyze the importance of retail banking relationships in an experimental setting where commercial banks have depositors and also underwrite securities. We are able to distinguish between the lead bank's own retail clientele vis-a-vis other retail clientele to ask if lead banks take advantage of their retail investors to dump "lemons" or whether their retail investors benefit from getting higher allocation of underpriced issues. We provide evidence that lead underwriters' retail customers demand more of the highly underpriced issues and end up with a higher allocation of underpriced issues. We use grey market prices to show that it is actual underpricing over and beyond that predicted by the grey market that drives the differential demand from the lead bank retail clientele. This is consistent with the bank passing on information about underpriced IPOs to their retail clientele and encouraging them to demand more of such issues. We next analyze the underlying incentives of the bank to treat their retail clientele well by examining cross-selling potential from other services of the bank by accessing data from the Central Bank. In particular, we document increases in both new brokerage accounts and retail consumer loans which are related to increased IPO underwriting, especially underwriting of underpriced IPOs by the commercial bank. We document brokerage accounts are sticky, they go up when IPO activity is high but are not shut down when IPO activity tapers off, and quantify that the economic benefits from the increase in brokerage accounts alone to the bank are substantial. We additionally provide evidence that increased IPO activity also goes hand in hand with additional cross selling through an increase in retail consumer loans. Interestingly, we do not see similar increases in corporate loans over the same time interval. Our results are robust to controls for competitive deposit and lending rates and to the use of instruments. Our evidence suggests retail banking relationships are important and provides a rationale for why this is the case.
Keywords: Banking, retail, relationships, cross-selling, underwriting
JEL Classification: G3
Suggested Citation: Suggested Citation