Rainer Haselmann, Christian Leuz and Sebastian Schreiber provide
evidence that German banks use knowledge acquired in lending relationships for trading purposes in Know Your Customer: Relationship Lending and Bank Trading. Universal banks combine
lending business with investment banking and brokerage services, which might raise conflict of interests. However, it is difficult to find a smoking gun for information exchange between different parts of an universal banks. The authors do so, by combining
detailed German data on banks’ proprietary trading and market making with lending information from the credit register. They then examine how banks trade stocks of their borrowers around important corporate events and find that banks trade more frequently
and also profitably ahead of events when they are the main lender (or relationship bank) for the borrower. Specifically, relationship banks are more likely to build up positive (negative) trading positions in the two weeks before positive (negative) news events,
and they unwind these positions shortly after the event. This trading pattern is more pronounced for unscheduled earnings events, M&A transactions, and after borrower obtain new bank loans. A back of the envelope calculation shows that on average, relationship
banks earn an additional trading profit of €3,890 per event. These results suggest that lending relationships endow banks with important information, highlighting the potential for conflicts of interest in banking, which has been a prominent concern in
the regulatory debate.