The cross selling of bank credit and other services a theoretical and empirical analysis

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The cross-selling of bank credit and other services : a theoretical and empirical analysis. Emmanuelle Nys* Preliminary Version May, 2002 Abstract Several recent studies have shown that banks have increased their service activities in recent years. This paper studies the cross-selling of services and credit, that is services sold by a bank because of an already existing credit banking relationship. In the theoretical model, we suppose that banks anticipate the potential sale of services to their clients when competing on the credit mar- ket. The question is whether this particular attitude a?ects the pricing strategy of banks as well as the risk borne on their balance sheet. Two of the main results derived from the analysis of the model is that services provision implies a lower loan interest rate and an increase of the average riskiness of all projects …nanced by banks. The study, undertaken in this paper, tests services provision as one of the explanatory variables of the credit rate, in twelve selected European countries during the period 1989-1999 for a sample of 1436 banks. The empirical results tend to con…rm the inverse impact of commissions revenue on loan interest rate. 0 I would like to thank Michel Cavagnac, Nick Horsewood, Andy Mullineux, Cillian Ryan, Alain Sauviat and Amine Tarazi for their very helpful com- ments. The usual disclaimer applies. *PhD Student, Centre de Recherche en Macro-économie Monétaire, Université de Limoges, and Global Finance Group, University of Birmingham (U.

• bank


• between loan


• deposit rates


• interest rate


• service


• banks


• existing bank-…rm


• project


• rate

Sujets

• Europe
• Cavagnac
• Université de Limoges
• Sauviat
• Interest rate
• Service

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• Publié par: chaeh
• Nombre de lectures: 37
• Langue: English

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T he cross-selling of bank credit and otherservices:atheoreticaland empirical analysis.

E mmanuelle N ys*

Preliminary Version

May,2002

A bstract

Severalrecentstudieshaveshownthatbankshaveincreased their service activities in recent years. T his paper studies the cross-sellingofservicesandcredit,thatisservicessoldbyabank because of an already existing credit banking relationship. In the theoretical model, we supposethat banks anticipate thepotential saleof services to their clients when competing on thecredit mar- ket. T he question is whether this particular attitude a¤ects the pricing strategy of banks as well as therisk borneon their balance sheet. Two of the main results derived from the analysis of the model is that services provision implies a lower loan interest rate andanincreaseoftheaverageriskinessofallprojects…nanced by banks. The study, undertaken in this paper, tests services provision as oneof theexplanatory variables of thecredit rate, in twelveselectedEuropeancountriesduringtheperiod1989-1999 forasampleof1436banks.Theempiricalresultstendtocon…rm the inverse impact of commissions revenue on loan interest rate.

0  Michel Cavagnac, Nick Horsewood, A ndy M ullineux,I would like to thank Cillian Ryan, A lain Sauviat and A mine Tarazi for their very helpful com- ments. T he usual disclaimer applies. * de acro-économie Monétaire, Université de Recherche en MP hD Student, Centre Limoges,andGlobalFinanceGroup,UniversityofBirmingham(U.K.)-4,placedu présidial - 87031 Limoges - France +33 (0)5.55.43.56.98, [e-mail]

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1 I nt roduct ion Theusualoperationalde…nitionofabankisan“institutionwhosecur- rentoperationsconsistingrantingcommercialloansandreceivingde- posits from the public” 1  commonly service. Another provided by banks totheirclientshasbeenthemanagementofcurrentaccountsinasso- ciated payment services, but this activity had not been fully priced in pastyears 2 .odevnaegaltstrehatamdraschlyalicagniknaBhytivitc two decades, due in part to …nancial liberalisation, as it is the case in Europeancountries.Commercialbankshavedevelopedservicesinad- ditiontotheircreditactivity,thestructureofbankrevenuehasbeen modi…ed. Over the last few years, the share of the non-interest income of banks’ revenue has grown faster. For example, in Europe, the share ofnon-interestincomeincreased 3 be2%eetw98n1nd9ao3%t26omfr 1995,andfrom32%to41%between1995and1998.Servicesprovided by banks cover a large range of activities including the management ofmeanofpayment,advisory/consultingactivities,brokerageservices, capital market asset trading, securitisation, etc 3 ... Considering this evolution, wemay wonder how the roleof banks has changedandhowthebank-customerrelationshiphasbeena¤ected.The existenceofbanks,inthistheoreticalmodel,isjusti…edbytheircapac- itytoreduceasymmetricand/orimperfectinformation.Moreprecisely, their role consists of screening the demand for loans and monitoring …rmsindebtedtothem.Weconsiderservicesprovisionasabankactiv- ity: more speci…cally we envisage that services are bought from banks because of an already existing bank-…rm relationship. Making loans is oneoftheprimaryactivitiesofbanks(alongwiththemanagementof current and saving/ deposit accounts). T he resulting relationships, and the information the banks get from them, make it easier for banks to cross-sellservicesandotherproductstotheirclients. Oneofthedi¢cultiesconcerningthemultiproductprovisionofbank- ingservicesisthatthepricingofserviceshasbeenthesubjectofgov- ernment interference/ regulation. For example K lein (1971), and Barro and Santomero (1972) have studied the demand for deposits and have pointedoutintheirrespectivearticlesthatwhenthegovernmentim- posesaninterestrateceilingoncurrentandsavingaccounts,bankspay animplicitinterestratebysettingchargesforservicesbelowthecompet-

1 De…nition given by Freixas and Rochet (1997), p1. 2  this paper weare focusing primarily on retail commercialI n rather than banking investment banking. Therefore we are not dealing with fee income from investment banking. 3Based on data published in ’EU Banks’ I ncome Structure’ the Bank-prepared by ing Supervision Committee for the European Central B ank.

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itive price. As Saunders and Schumacher (2000) show in their empirical study over the1988-1995 period, theimplicit interest rate(undercharged services)hasasigni…cantandpositiveimpactonnetinterestmargins. Intheeighties,regulationconcerninginterestratesoncurrentandsav- ingaccountshastendedtodisappear.Asaconsequenceofderegulation, bankshaveincreasedtheshareofthecostsofservicesprovisionthey charge to clients (J acolin and Paquier (1995)) 4 . Ourviewisthattherecentyearsmayhaveseenthedevelopmentof a new strategy: after the deregulation of deposit rates, when competing for market share on the loan market, banks anticipatethe potential sale of services in futureperiods. Wethen wonder if this new activity enables banks to decreasethepriceof loans, which would explain a lower interest margin (even possibly dumping or loss leading). We are interested here byapossiblecross-subsidisationontheloanmarket,anditse¤ecton theriskiness of project that thebank chooses to …nanceand thus on the banks’riskbehaviour. The paper is organised as follows: section 2 develops a model using a principal-agent theory structure based on the paper of Covitz and Heit- …eld (1999). Theparticular featureof themodel hereis theintroduction of services in thepro…t function of banks. T he aim of this model is thus to investigate the impact of services revenue as an explanatory variable of the loan interest rate, as well as its impact on banks’ behaviour with regard to loan monitoring and entrepreneurs’ behaviour concerning the risk level of their project. Section 3 …rst explains thelogic of our testing method. It gives as well the data sample on which regressions will be run. At last, this section presents the results of the tested relationship betweenloaninterestrateandcommissionsrevenue.Finally,section4 concludes.

2 T he model Inthismodel,abankprovidescredittoone…rminthe…rstperiod.The latter will pay back its loan at the end of this period. While lending to the …rm, the bank develops a banking relationship with its client that maypotentiallyenablethebanktosellservicesinthesecondperiod. Ouraimistounderstandhowsellingservicescanalter…rms’behaviour towards project risk. 4 banks charge the hen W of e¢ ciency. in terms could be the e¤ect issueA nother real price for services they provide to their clients, they eliminate cross-subsidisation between clients.

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