Hidden cost of better bank services: carefree depositors in riskier banks?

Abstract: Better customer service helps banks attract core deposits and increase funding stickiness by raising depositors? switching costs and enhancing their loyalty. This funding stickiness, however, could impair market discipline and lead to excessive risk-taking. We find that banks providing better services attract more core deposits, pay less for their funding, and are exposed to lower funding outflow risks. At the same time, these banks carry lower quality loans. We argue that this contradictory finding of cheaper funding cost with lower asset quality stems from the lack of risk monitoring by loyal, sticky depositors, which exacerbates agency problems.

Keywords: bank liability; funding cost; deposit; risk taking; market discipline;

JEL Classification: G20; G21;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2017-02-01

Number: 760