Relationship banking can help to minimize principal agent and adverse selection problems.
Lender and borrower are said to have a relational contract if there is an understanding between both parties that it is likely to be some time before certain characteristics related to the contract can be observed. Over an extended period of time, the customer relies on the bank to supply financial services. The bank depends on long-standing borrowers to repay their loans and to purchase related financial services. A relational contract improves information flows between the parties and allows lenders to gain specific knowledge about the borrower. It also allows for flexibility of response should there be any unforeseen events. However, there is more scope for borrower opportunism in a relational contract because of the information advantage the borrower normally has.
The J¨urgen Schneider/Deutsche Bank case is a good example of how relationship banking can go wrong. Mr. Schneider, a property developer, was a long-standing corporate client of Deutsche Bank. Both parties profited from an excellent relationship over a long period of time. However, when the business empire began to get into trouble, Schneider was able to disguise ever-increasing large debts in his corporation because of the good record and long relationship he had with the bank. Schneider forged loan applications and other documents to dupe Deutsche and other banks into agreeing additional loans. In 1995, he fled Germany just as the bank discovered the large-scale fraud to cover up what was essentially a bankrupt corporation. After nearly 3 years in a Florida prison, Mr. Schneider gave up the fight against extradition and was returned to Germany to face the biggest corporate fraud trial since the end of the Second World War. In 1998, he was convicted of fraud/forgery and given a prison term of 6 years, 9 months. The judge criticized German banks for reckless lending. Outstanding loans amounted to $137 million. Deutsche Bank apologized for improper credit assessment, especially its failure to follow proper procedures for loan verification.

Banking institutions include commercial banks, savings and loan associations (SLAs), savings banks, and credit unions. The major differences between these types of banks involve how they are owned and how they manage their assets and liabilities. Assets of banks are typically cash, loans, securities (bonds, but not stocks), and property in which the bank has invested. Liabilities are primarily the deposits received from the bank’s customers. They are known as liabilities because they are still owned by, and can be withdrawn by, the depositors of the financial institution.
Until the early 1980s, the assets and liabilities of banks were tightly regulated. As a result, clear distinctions existed between the activities and types of services offered by these different types of banks. Although subsequent deregulation in the 1990s blurred these distinctions, differences do remain.