Relationship banking involves going the beyond the normal banking services and understanding customer’s needs before offering him any special product. The knowledge about existing and potential clients is essential for all banks. The customers don’t give away certain details in routine banking operations. The banks have thus introduced the concept of relationship banking which is making a deliberate effort to gain soft information like his competence, type and quality of business, personal integrity etc. about a customer and then offer him products which are best suited to his requirements. Such information is essential in case of credit screening in small firms which are mostly opaque businesses and have lesser number of measurable outcomes. This is a win-win situation for both as the banks get personalised information about customers through a series of contacts and the customers also develop a sense of responsibility to repay their liabilities in time as part of their loyalty to the bank. This reduces moral hazard behaviour and default.
Banks appoint special officers as personal relationship managers who classify their existing and potential clients into categories like high intensity borrowers, medium intensity borrowers, low intensity borrowers, comparison group etc. depending upon the level of willingness they had in any of the bank’s products and also the level of personalised attention the relationship officer will give in terms of meetings, follow-ups etc.
Thus, it helps in the following situations:
- There is ample room for flexibility of contracts based on the soft information gathered. This helps in making long-term contracts.
- The banks have better control over many factors and thus any existing or plausible conflicts of interests can be safely handled.
- It may help banks get life-long, loyal customers who place more faith in the bank than other financial institutions for any fund requirement.
- Liquidity constraints are well handled and business risks are suitably shared between the banks and big ticket clients.
It may come in way of smoother transactions in the following ways:
- Inefficient investments can rise due to soft-budget constraints leading to repeated renegotiations about loans.
- Firms may become risk averse as the banks may discourage any high risk venture.
Relationship banking is found in many countries like US, Germany, Japan etc.