The structure of the financial services industry is in flux. Liberalization, deregulation, and advances in information technology have changed the financial landscape dramatically. Interbank competition has heated up and banks face increasing competition from nonbanking financial institutions and the financial markets. The predictability of the industry with low levels of financial innovation, little innovation in distribution channels and well defined and rigid institutional structures is gone. Product innovations, new distribution channels, and emerging new competitors are in abundance. Moreover, the subprime crisis that has hit the financial sector in 2007-2008 appears to have a major impact on the structure of the industry. This article emphasizes the importance of understanding the economics of banking for assessing the changes in the industry. In particular, we point at relationship banking as a prime source of the banks' comparative advantage. The proliferation of transaction-oriented banking (trading and financial market activities) does however seriously challenge relationship banking. In order to focus on these issues in a rigorous way, we will evaluate the key insights from the relationship banking literature, including the potential complementarities and conflicts of interest between intermediated relationship banking activities and financial market (underwriting, securitization, etc.) activities. We also address the issue of the optimal conglomeration of bank activities, including the empirical evidence on scope and scale economies. We analyze the strategic positioning of banks in the currently highly uncertain competitive arena, and link this to the theory of the firm and particularly firm boundaries and learning. Copyright 2008 , Oxford University Press.
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