Relationship banking, fragility, and the asset-liability matching problem

Fenghua Song, Anjan V. Thakor

Research output: Contribution to journalArticle

61 Scopus citations

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 they also 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 banks fragility owing to withdrawal risk and maximizes the value the bank adds in relationship lending. We also examine the impact of interbank competition on the banks asset-liability matching and extract numerous testable predictions.

Original languageEnglish (US)
Pages (from-to)2129-2177
Number of pages49
JournalReview of Financial Studies
Volume20
Issue number6
DOIs
StatePublished - Nov 1 2007

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics

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