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Boot, A. and Ratnovski, L. (2016). Banking and Trading Review of Finance, 20(6):2219--2246.

  • Journal
    Review of Finance
View publication

We study the interaction between relationship banking and short-term arm{\textquoteright}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.