Thesis_gd_final_vers.. - Vernimmen

monitoring costs incurred in the framework of lending relationship can be spread on more
products. Moreover information can also be re-used across the different product lines in order to
better assess client-specific risks and improve the risk-return profile of the bank’s activities. The
existence of scope economies based on relationship increased the competition for gaining new
customers. It thus has become widespread to offer underpriced corporate loans in order to attract
new customers (Calomiris (2000)). The measure of profitability is consequently no more assessed
on an individual transaction basis, but on a relationship basis by evaluating the resources devoted
to a client against the revenues that the same client generates in the form of interest payments and
fees for the bank.
The best illustration of the existence of scope economies based on information-sharing and
informational advantage comes from the entry of commercial banks into the security underwriting
business though section 20 subsidiaries in the 1990s. Pappaioannou (2008) shows that commercial
banks entered the underwriting business successfully. Their performance is particularly strong in
debt underwriting and Yankee underwriting where they captured on average 58% and 60%
respectively of the market over 2001-2004 versus only 19% and 15% respectively over 1990-1996.
Their market share in equity and in municipal bonds underwriting also surged from 5% and 12%
respectively over 1990-1996 to 40% and 36% respectively over 2001-2004. This gain in market
share was mostly at the expense of independent investment banks. The top-6 bulge bracket
investment banks also experienced a decline in market share over the 1990s and early 2000s except
for equity offerings where they reinforced their positions overtime. Even though commercial
banks had an information advantage due to their lending relationships with securities issuers this
did not translate into significantly higher market share gain for high information content securities,
for which the price discovery process is more complex. However, they were able to charge lower
gross spread on debt underwritings according to Rotten and Mullineaux (2002), and the
underpricing was reduced even more for non-investment grade bonds, which accredits the
informational advantage of commercial banks resulting from scope economies. Concerning the
equity underwriting market, Pappaioannou (2008) findings also suggest that small-sized first-time
issuers for whom information asymmetry is greater tend to favour commercial banks with which
they have lending relationships, rather than investment banks. More generally a bank with a
lending relationship with an issuer is more likely to underwrite debt or equity issues (Barath et al.
(2007).
The product diversification had a dramatic impact on the banking industry as a whole, even
though banks from different sizes have been impacted to different degrees. Berger and Mester
(2003) found that a larger product scope of commercial banks translated into both a worsening of
cost productivity and an improvement of profit productivity from 191 to 1997. This means that
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