Hidden cost of better bank services: Carefree depositors in riskier banks?

Better customer service provisions by banks - such as more branches and ATMs, longer business hours, and more personalized services - help attract more core deposits and increase funding stickiness by raising depositors' switching costs and enhancing their loyalty. Funding stickiness from depositor loyalty, however, could impair market discipline and lead to excessive risk taking or lax lending standards in banks. We find that, compared to banks that spend less on customer services, 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 have worse loan quality and lower Z-scores. We argue that this contradictory finding of low asset quality and low funding cost stems from the lack of risk monitoring by carefree depositors, which exacerbates agency problems; funding cost is less sensitive to the risk characteristics of banks providing better services.