Relationship Banking, Fragility and the Asset-Liability Matching Problem

50 Pages Posted: 8 Aug 2006

See all articles by Fenghua Song

Fenghua Song

Pennsylvania State University - Smeal College of Business

Anjan V. Thakor

Washington University in St. Louis - John M. Olin Business School; Financial Theory Group; European Corporate Governance Institute (ECGI); Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering

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Abstract

We address a fundamental question in relationship banking: why do banks that make relationship loans finance themselves primarily with core deposits and when would it be optimal to finance such loans with purchased money? We show that not only are relationship loans informationally opaque and illiquid, but require the relationship between the bank and the borrower to endure in order for the bank to add value. However, the informational opacity of relationship loans gives rise to endogenous withdrawal risk that makes the bank fragile. Core deposits are an attractive funding source for such loans because the bank provides liquidity services to core depositors and this diminishes the likelihood of premature deposit withdrawal, thereby facilitating the continuity of relationship loans. That is, we show that banks will wish to match the highest value-added liabilities with the highest value-added loans and that doing so simultaneously minimizes the bank's fragility due to withdrawal risk and maximizes the value the bank adds in relationship lending. We also examine the impact of interbank competition on the bank's asset-liability matching and extract numerous testable predictions.

Suggested Citation

Song, Fenghua and Thakor, Anjan V., Relationship Banking, Fragility and the Asset-Liability Matching Problem. Review of Financial Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=922369

Fenghua Song

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802
United States
814.863.4905 (Phone)

HOME PAGE: http://sites.google.com/site/fenghua8song/

Anjan V. Thakor (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Financial Theory Group ( email )

United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering ( email )

100 Main Street, E62-618
Cambridge, MA 02142
United States

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