Professional Documents
Culture Documents
Todays Lecture
What are the benefits and costs of relationship banking? What are the characteristics of a long-term underwriting relationship?
Case study: the collapse of Lehman Brothers
Readings: Boot (2000) Boot and Thakor (2000) Burch, Nanda and Warther (2005)
Transaction banking
Concentrates on a single transaction With a large number of customers Bank receives information from the interaction with various customers
Relationship banking
Relationship banking usually discussed for the lending of commercial banks Can also be applied to IB Achieve a relationship with customers generate information that can be used in future transactions:
Repeated underwriting of shares/bonds Repeated M&A advisory or other consultancy work Use of financial products (e.g. for risk management) Continued analyst coverage Investments into stock, bank or money market For universal banks with lending activities relationship extends to IB
Lending relationship future underwriting IPO underwriting future lending
Costs
Soft-budget constraint problem Hold-up problem (information monopoly)
Information production
Customers more likely to reveal sensitive information and bank more willing to invest in information production Customers get a specific service Information sharing reduces asymmetries Information production is costly but IB can reuse this private information Bank can set much more precise terms for transactions (e.g. IPO or M&A), increasing their reputation and the success of the transaction in the market
Proximity between bank and company allows for better monitoring of collateral Can mitigate moral hazard and adverse selection problems Funding of contracts that are not profitable for IB in the short-term (e.g. develop new financial product for the need of the company), but may be profitable in a long-term relationship IB can recover any loss in later transactions Customer may accept less favourable terms of contract that he could get elsewhere Long-term profits for both sides
Hold-up problem: Information monopoly of the bank prevents competitors to offer better terms Customer is locked in his relationship
Existence of switching costs Having multiple relationships (common nowadays) reduces this problem at least partially
Empirical evidence
Relationship banking generates additional value for both IB and customers
Banks acquire information over time Positive impact of announcement effect Even more valuable for small companies
Increase credit availability + reduce funding costs & collateral requirements
Decline in loyalty since mid-1990s What are the determinants of loyalty? Does it pay to be loyal?
Reputation of underwriter
Clients of larger/more prestigious IB are more loyal Wide range of services/products Add prestige for small companies
Empirical findings
Benefits of loyalty for common stock offers
Loyalty to a bank decreases fees
Underwriter certification more important in common stock offers relative to debt offers (third-party debt ratings available)
Questions
What are the two main costs of relationship banking? How can customers reduce these costs? What are the determinants of loyalty?
Underwriting is the principal component of the IB relationship that is irreplaceable without cost Consistent with equity underwriting relationship being valuable for issuers (especially IB with high reputation)
Information production for subsequent offerings IB monitoring + investor base
No abnormal impact for debt underwriting, M&A, analyst coverage and market making clients
Relationship banking: Banks can differentiate from competitors, lowering exposure to price competition
Tailoring their service to the needs of customers Need information only available through long-term relationships
Conclusion on competition
Increased competition has more effect on transaction banking through price competition, while relationship banking allows for differentiation Impact for IB:
Relationship banking becomes more important But profits are reduced through competition
Question:
Why is equity underwriting relationship most valuable for issuers?
Next week
External speaker: Azeem Malik Presentation on:
Structured products Asset-liability matching Post-crisis risk management New product ideas?