How Big Banks Keep Their Biggest Customers

Why are the big banks bigger? That's easy. The government spent lots of money feeding the dying big banks, like Wachovia and Washington Mutual, to the slightly healthier and bigger banks, like Wells Fargo and JPMorgan, which made the "Too Big to Fail" banks even fatter. But James Surowiecki wants to know something else: Why have the big banks found it so easy to hang onto their customers?

Reflexively, the answer seems intuitive to me*: Americans are resistant to change, we trust big names, and switching costs are high enough to be prohibitive for most customers. But why is corporate banking similarly inert? Surowiecki writes:

The biggest driver of business in investment banking, I argue, is reputation. And while reputation is certainly to some extent earned--on Wall Street as in other reputation-driven businesses, you don't become well-regarded without performing well--it's also clear that after a certain point reputation takes on a life of its own, particularly when it comes to things like M. & A. advice and underwriting.

Megan McArdle had some killer thoughts on the role of big investment banks in mergers and public offerings two months ago. Her nutshell thesis was that some one-time-only events -- like movie trailers and  IPOs -- are too important to take risks. So producers spend $300,000 on a 20 second voice over from a pro rather than try a cheapo because "a bad voice-over would cost you far more than you could hope to save." The same logic

"explains why clients have been willing to pay investment banks lavish fees to do IPOs--and secondary offerings, and bond underwriting, and M&A, and advisory work. The mystery of investment-banking fees is often framed as a matter of banks rooking naive managers, or managers selling out their shareholders in return for a space on Merrill Lynch's private jet. But the venture capitalists behind many of the IPOs aren't neophytes at the mercy of big-city bankers; both they and the firm's managers depend on a strong IPO, and a liquid aftermarket, to allow them to get some of their money back out of the company. If they're tolerating such large fees, there must be a reason."

*In the spirit of full disclosure, I'm a Bank of America customer. The reason I chose BofA over a smaller northern Virginia bank when I moved to Arlington, VA, wasn't very exciting. I liked the Keep the Change policy and they have a lot of ATMs in Washington, and just about everywhere else.

This article available online at:

http://www.theatlantic.com/business/archive/2009/10/how-big-banks-keep-their-biggest-customers/29055/