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<P>FDIC Center for Financial Research Working Paper</P>
<P><BR>On the Importance of Retail Banking Relationships</P>
<P>While the importance of bank-firm relationships is well documented in the banking literature,<BR>there is relatively little research on the importance of retail banking relationships. In this<BR>paper we collect proprietary data from multiple sources to analyze the importance of retail<BR>banking relationships in an experimental setting where commercial banks have depositors and<BR>also underwrite securities. We are able to distinguish between the lead bank’s own retail<BR>clientele vis-à-vis other retail clientele to ask if lead banks take advantage of their retail<BR>investors to dump “lemons” or whether their retail investors benefit from getting higher<BR>allocation of underpriced issues. We provide evidence that lead underwriters’ retail<BR>customers demand more of the highly underpriced issues and end up with a higher allocation<BR>of underpriced issues. We use grey market prices to show that it is actual underpricing over<BR>and beyond that predicted by the grey market that drives the differential demand from the lead<BR>bank retail clientele. This is consistent with the bank passing on information about<BR>underpriced IPOs to their retail clientele and encouraging them to demand more of such<BR>issues. We next analyze the underlying incentives of the bank to treat their retail clientele<BR>well by examining cross-selling potential from other services of the bank by accessing data<BR>from the Central Bank. In particular, we document increases in both new brokerage accounts<BR>and retail consumer loans which are related to increased IPO underwriting, especially<BR>underwriting of underpriced IPOs by the commercial bank. We document brokerage accounts<BR>are sticky, they go up when IPO activity is high but are not shut down when IPO activity<BR>tapers off, and quantify that the economic benefits from the increase in brokerage accounts<BR>alone to the bank are substantial. We additionally provide evidence that increased IPO<BR>activity also goes hand in hand with additional cross selling through an increase in retail<BR>consumer loans. Interestingly, we do not see similar increases in corporate loans over the<BR>same time interval. Our results are robust to controls for competitive deposit and lending<BR>rates and to the use of instruments. Our evidence suggests retail banking relationships are<BR>important and provides a rationale for why this is the case.</P>
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