Big broad banks: how does cross-selling affect lending?
Yingjie Qi
Review of Finance, Volume 28, Issue 2, March 2024, Pages 551–592, https://doi.org/10.1093/rof/rfad028
Cross-subsidization across multiple products is shown to increase equilibrium profit and reduce competition in the IO literature. This strategy has been documented in many industries, in which firms advertise a base price for a product and try to sell “add-ons” at high prices at the point of sale. For example, in retail, loss-leaders such as white bread and eggs are offered to increase store traffic. Once consumers are in the store, firms extract consumer surplus through the sale of other goods. In banking, loans are natural candidates for loss-leaders: they are frequently used and sought by most customers. Since many of the non-loan products are complements to loans, total revenue increases when banks cross-sell.
Even though profits from non-loan products nowadays account for about 40% of large banks’ net operating revenue in many countries, causal link between cross-selling profit and bank lending decisions has not yet been established. The main challenges include a lack of micro-level data on firm-bank relationships and difficulties in disentangling the cross-subsidization channel from alternative explanations such as firm quality and relationship information.
This paper provides evidence of cross-subsidization in banking by combining both detailed internal data from one large Northern European bank and an exogeneous shock to identify the cross-subsidization channel in isolation. The paper first shows that non-loan profit predicts higher credit supply and the likelihood of receiving lenient treatment from the bank when a firm is in distress. It then establishes a causal link between the two by demonstrating that when profit from non-loan products decreases due to the implementation of Basel II, both credit supply and lenience in delinquency to affected firms decrease.
These findings imply that cross-selling matters for lending decisions not only because it reduces information asymmetry (as shown in previous relationship banking literature) but also because loans are often underpriced, and non-loan products are the more important source of profit in bank-firm relationships. Policymakers should therefore carefully consider the trade-offs between the increased credit supply and the potential credit misallocation problems. On the one hand, the profit from cross-subsidization between loan and non-loan products increases the long-term incentives for banks to support their borrowers, leading to more credit supply and greater tolerance during borrower distress. On the other hand, evergreening and capital misallocation might happen because borrowers are not only evaluated based on their creditworthiness but also their cross-selling potential.