Banking and Trading. (27th January 2016)

• Record Type: Journal Article
• Authors: Boot, Arnoud W. A.; Ratnovski, Lev
• Is Part Of: Review of finance. Volume 20:Number 6(2016)
• Page Start: 2219
• Page End: 2246
• Publication Date: 2016-01-27
• Subjects: G21 -- G24 -- G28 -- G32; Finance -- Europe -- Periodicals; Financiën; Finance; Periodicals; 332.09405
• DOI: 10.1093/rof/rfv069
• Languages: English
• ISSNs: 1572-3097

Abstract

Abstract : We study the interaction between relationship banking and short-term arm's length activities of banks, called trading. We show that a bank can use the franchise value of its relationships to expand the scale of trading, but may allocate too much capital to trading ex post, compromising its ability to build relationships ex ante . This effect is reinforced when trading is used for risk shifting. Overall, combining relationship banking and trading offers benefits under small-scale trading, but distortions may dominate when trading is unbridled. This suggests that trading by banks, while benign historically, might be distortive with deeper financial markets.