Can Relationship Banking Survive Competition?

Arnoud Boot and Anjan Thakor ()

No 1592, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We develop a model of the banking firm that is intended to reflect contemporary trends in the evolution of banks. In particular, we focus on the effects of both interbank and capital market competition on the role of banks in funding corporations. In our model, banks can choose to provide loans that are similar to capital market funding (transaction loans) or loans that involve unique bank-specific services (relationship loans). Borrowers can choose one of these two types of bank loans or directly access the capital market. Our key result is that, contrary to what many believe, a bank’s optimal response to increased competition is to expand relationship lending relative to its transaction lending. The behaviour of the absolute level of relationship lending with respect to increasing competition is non-monotone. Initially, an elevation in competition leads to an increase in the expected level of relationship lending, but then the expected level of relationship lending falls as competition rises further. Moreover, the viability of relationship banking depends significantly on the reputational quality of banks.

Keywords: Commercial Banking; Financial System Design; Investment (search for similar items in EconPapers)
JEL-codes: G10 G24 (search for similar items in EconPapers)
Date: 1997-03
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Citations: View citations in EconPapers (48)

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Journal Article: Can Relationship Banking Survive Competition? (2000)
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