In this article, We’ll learn why we need to make a very important distinction between two terms we’ll use from time to time in the course transactional and relationship banking. It makes sense to distinguish them, given that these are the main approaches investment banks could apply when formulating their strategies and deciding how to interact with clients. A good analogy to describe transaction banking would be to compare it to a barber shop that is very efficient in terms of costs and pricing and manages to serve many people every day.
The business is about a high volume of transactions. Each of these transactions has a moderate but still healthy profit margin. For the barber shop to be truly profitable. Many people need to go through the door every day. The number of chairs in the shop is fixed, so the only variable to be optimized is the amount of time the barber spends per haircut.
The service offered would be basic, involving a limited degree of customization, assistance, and recommendations.
Similarly, a transaction-oriented bank would sell standardized products involving a lesser degree of customization. This isn’t necessarily a bad thing for the bank or the clients. The bank has a high client turnover and can minimize its risk from particular client accounts. In addition, the overall amount of fees will probably be higher due to more deals being closed from the client side.
A transaction-based approach may be preferred in a context where they don’t need the bank’s advice and would prefer to keep costs at a minimum. Of course, transaction banking is more economical because bankers invest less of their time when serving a given client account. Relationship banking, on the other hand, can be easily compared to a costly hairstylist salon. There is time for fewer people per day, but the ones who come in are truly special, and frankly, these are premium clients willing to pay more and hence worth the stylists’ time before giving them a haircut.
The stylist would discuss current fashion trends, and together they will figure out an optimal solution. Not only that but from time to time, the stylist would be happy to share their opinion about the trendiest nightclubs in the city and even make a call to book a table on the client’s behalf. Clients typically stick with their stylists for years and are happy to invest in that relationship, paying significantly higher prices for a superb service. Relationship banking is about establishing contact with important company executives and cultivating that relationship throughout the years to win their business.
One aspect that was missed in the hair stylist example is that relationship banking frequently involves a significant time investment before bankers see any kind of return. They have to go to great lengths and arrange calls, meetings, dinners and provide valuable advice before being able to win any business, and of course, there’s always a risk that the banker would invest a lot of time and end up with no business from a particular relationship.
So transaction-based banking is usually the preferred route by most banks nowadays. Many investment bankers are understandably nostalgic about the idea of relationship banking, and this is also one of the reasons for the formation of boutique advisory firms that focus on serving clients in a similar way to relationship banking. The idea of relationship banking is much more romantic and is probably also the best way for a great banker to prove their value to a client. Sticking with an executive for years, knowing their story, having an idea of how their company functions, understanding the industry, and being able to observe a client’s thought process allows a banker to become a valuable advisor needed at times when the company is at a crossroads.
