Staff Reports
Hidden Cost of Better Bank Services: Carefree Depositors in Riskier Banks?
January 2016 Number 760
Revised June 2018
JEL classification: G20, G21

Authors: Dong Beom Choi and Ulysses Velasquez

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.

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