商业银行和投资银行

Electronic copy available at: http://ssrn.com/abstract=2055149 Running head: Separating Commercial and Investment Banking 1 Commercial Banking and Investment Banking: Separation vs. Unification Richard Lartey  , PMP SMC University Switzerland May 5, 2012  The views expressed in this paper are the author’s alone. I am extremely grateful to Dr. John H. Nugent, Associate Professor, School of Management, Texas Woman’s University, for constructively reviewing this paper and providing valuable comments. But of course, the usual disclaimers apply and any mistake is the author’s only and does not engage anyone but the author! Electronic copy available at: http://ssrn.com/abstract=2055149 Separating Commercial and Investment Banking 2 Table of contents Table of contents ........................................................................................................................................... 2 Abstract ......................................................................................................................................................... 3 1.0 Introduction ....................................................................................................................................... 4 2.0 Discussion of the facts and issues ..................................................................................................... 5 2.1 Commercial Banking .................................................................................................................... 5 2.2 Investment Banking ...................................................................................................................... 6 2.3 Separation of Commercial and Investment Banking .................................................................... 7 3.0 Analysis of the facts and issues ......................................................................................................... 9 3.1 Common premise for Commercial and Investment Banking ........................................................ 9 3.2 Unified Banking vs. Separated Banking ..................................................................................... 10 4.0 Conclusion ...................................................................................................................................... 13 5.0 Recommendations ........................................................................................................................... 13 References ................................................................................................................................................... 14 Electronic copy available at: http://ssrn.com/abstract=2055149 Separating Commercial and Investment Banking 3 Abstract Over the past years, the global financial sector has undergone tremendous transformation as banking concentration has increased in all banking markets. Increased competition in the banking industry warrants increased attention of the financial sector regulatory authority to segregate commercial banking from investment banking. The public-interest discourse for the separation of commercial banking from investment banking is weak and appears unable to explain the provisions of the Banking Act. The paper found that the rationale for the separation of commercial and investment banking was ill-founded. Keywords: Banking, Commercial Bank, Investment Bank, Regulation, Deregulation Separating Commercial and Investment Banking 4 1.0 Introduction Several complexities exist in today’s world of banking and finance. Although banking regulation has changed the operational platform in which commercial and investment banks amalgamate, the nitty-gritty of their different businesses remain integral. While most private banks are able to conduct the full range of banking activities, some tend to specialize in investment banking, asset management, and trust business. In the 1960s, commercial banks were the largest providers of venture-capital financing (Craig, n.d.). However, the banking landscape has over several decades been heavily affected and shaped by regulation and structural barriers between different financial services aimed at deepening competition in the industry. Rivalry among banks is often brandished by gargantuan political and economic power. Prior to the passage of the Banking Act of 1933, bank regulation was greatly tightened in the United States which led to more than 9,000 banks failing during the great depression years of 1930-1933 (LaRoche, n.d.). Many experts including the legislature have blamed these failures on the alleged unethical actions arising from the amalgamation of commercial and investment banking. According to LaRoche (n.d.), these failures happened for three main reasons: “banks invested their own assets in risky securities, unsound loans were made to boost the price of securities of companies whom the bank had invested in, and the commercial banks interests in the price of securities tempted bank managers to pressure customers to purchase risky securities that the bank was trying to sell.” Although there was little or no evidence of blaming banks’ failures on unified banking, there were differences of opinion between those who sought to separate commercial banks from investment banking activities and those who favoured permitting such activities (Craig, n.d.). While the separation of commercial and investment banking was rationalized using public speaking, many authors have an opposing view that this public-interest rhetoric cannot be Separating Commercial and Investment Banking 5 supported theoretically or factually. It is argued that banks whose activities focused on integrating commercial and investing banking were safer than stand-alone commercial banks and they issued higher quality securities than independent investment banks (Tabarrok, n.d.). This paper discusses the concepts of separating commercial banking from investment banking. It analyzes the regulatory provisions of the Glass-Steagall Act of 1933 that gave rise to the separation of commercial banking from investment banking and provides a comparison between split banking (separating commercial banking from investment banking) and unified banking (combining commercial banking with investment banking). 2.0 Discussion of the facts and issues The difference between commercial banking and investing banking lies mainly in the services they provide, and to whom they are provided. This section explores the differences between commercial banking and investment banking operations and discusses the issues relating to the separation of these banking activities. 2.1 Commercial Banking A commercial bank generally provides basic banking needs such as loans to individuals and small and large businesses. Through commercial banking activities, funds are raised by collecting deposits from these individuals and organizations, charging interest on loans, and purchasing bonds from governments and corporate entities. Commercial banking process is easy and straightforward. In a dynamic theoretical framework, commercial banks compete for customers by setting acceptance criteria for granting loans, taking regulatory requirements into account. By easing its acceptance criteria, a commercial bank faces a trade-off between attracting more demand for loans, thus making higher per period profits, and a deterioration of the quality of its loan portfolio, thus tolerating a higher risk of failure (Bolt & Tieman, 2004). Separating Commercial and Investment Banking 6 Traditional commercial banks hold nonmarketable or illiquid assets that are funded largely with deposits (Boot, 2008). Commercial banks are more risk averse than investment banks since their traditional line of business focuses on accepting deposits and making loans available to borrowers, thereby receiving profit only if the borrowing corporations repay. Vault (n.d.) found that even before the repeal of the Glass-Steagall Act, commercial banks have long competed for the business of legally underwriting debt directly with investment banks, and some of the largest commercial banks have developed substantial expertise in underwriting public bond deals. 2.2 Investment Banking From a transaction orientation perspective of modern banking, investment bank’s role could be interpreted as that of a broker; i.e., matching buyers and sellers for the firms’ securities. Modern banking practices have narrowed the description of an investment bank’s economic role as investment banks’ added value are often confined to their ability to economize on search or matching costs (Boot, 2008). But Boot (2008) argues that investment banks do more to the extent that they almost without exception underwrite public issues, thereby absorbing credit and/or placement risk. Investment banks, by nature, are not financial intermediaries i.e. they focus on assisting corporations in the issuance of securities (principally stocks and bonds), hence they have higher risk tolerance levels than do commercial banks. LaRoche (n.d.) accentuates that the reputations of investment banks are indicted when they assist companies that perform poorly, in spite of the fact that the receipt of revenue not being tied to the performance after issuance makes them relatively risk tolerant. In their paper, Altınkılıç, et al. (2007) found that investment banks’ governance has responded to the deregulation of commercial bank entry into investment banking by virtue of the Separating Commercial and Investment Banking 7 repeal of the Glass-Steagall Act. An investment bank, however, often focuses on investing a depositor’s assets in a finance portfolio and managing these investments. For an investment bank, the processing and absorption of risk is a typical intermediation function similar to a commercial bank engaged in lending (Boot, 2008). Unlike commercial banks which already have funds available from their depositors, investment banks typically do not earn interest; they spend considerable time finding investors in order to obtain capital for their clients. With this in mind, an investment bank involved in the offering does not own the bonds but merely places them with investors at the outset and the bondholders earn this interest in the form of regular coupon payments (Vault, n.d.). 2.3 Separation of Commercial and Investment Banking Recent debates over the structure and performance in the banking system have some antecedents from researches based on the German, British and American banking system. Unlike other developed countries, the U.S. has historically maintained a severance between commercial banking and investment banking until the late 1980s. Due to the persistent challenges in the banking system, certain regulatory and legislative mechanisms have been put in place by various governments to segregate commercial and investment banking practices and to combat banking crisis. One of such frameworks is the Banking Act of 1933, also known as the Glass-Steagall Act, which was enacted to isolate commercial banking from investment banking (Tabarrok, n.d.). In alignment with the provisions of the Glass-Steagall Act, some proponents emphasized that the segregation of commercial banking activities from that of investment banking would enhance investor and customer safety while lowering conflicts of interest both on the part of the bank and customers. Separating Commercial and Investment Banking 8 The regulatory provision of the Glass-Steagall Act which impacted significantly on the banking industry was the limitation of interest rates on deposit accounts, registration of bank holding companies, extension of statewide branching rights to national banks in states permitting similar rights for state-chartered institutions, and the separation of commercial and investment banking (Filipiak, 2009). With this legal provision, the severance of commercial and investment banking activities certainly aided commercial banking by protecting its industry from competitors in a closely related field that had lost all value. The risk tolerance and culture differences between commercial and investment banks make them to be likened to the “water and oil” phenomenon; they can never mix. While commercial banks and investment banks are complementary in some areas, differences in their level of risk tolerance and culture pose serious challenges when they are merged. For example, the merger of J.P.Morgan and Chase Manhattan Bank was one that was perceived by many analysts to have proven beneficial but the culture clash and risk tolerance differentiation prevented the new firm from ever achieving the synergies the financial world was expecting (LaRoche, n.d.). From a micro-historic perspective, some individual bankers spearheaded the provisions of the Glass-Steagall Act that separated commercial banking from investment banking. But some authors argue that although the Banking Act was benefited from and supported by only private interest groups such as investment bankers, they provided no direct evidence (Shughart, 1988; Macey, 1984; Benston, 1982, cited in Tabarrok, n.d.). In the case of the Morgans vs. the Rockefellers, separation of commercial and investment banking hurt the House of Morgan disproportionately whilst it offered the Rockefeller group a decisive advantage in their battle with the Morgans although their cost of banking was raised (Tabarrok, n.d.). Prior to the enactment of the Glass-Steagall Act of 1993, a lot of concerns were raised with regards to abuses by investment banks that were affiliated to commercial banks. These Separating Commercial and Investment Banking 9 investment banks were alleged to have over-stated the quality of the underwritten securities issued by the commercial banks’ clients, packaged bad commercial loans into securities, misused responsibility for trust accounts etc (FRBSF, 1995); hence the need to pass the Glass-Steagall Act to proscribe commercial banks from undertaking investment banking activities with the object to protecting investors’ interest from future abuses. The isolation of commercial banking from investment banking was intended to “maintain the integrity of the banking system, prevent self-dealing and other financial abuses, and limit stock market speculation (Jackson, 1987). 3.0 Analysis of the facts and issues Commercial Banks and Investment banks operate at different levels. But as far as companies are concerned, they use and treat investment banks as commercial banks. Thus commercial banking and investment banking both involve the provision of financial services and advice to individuals and organizations. This section analyzes the similarities and common activities of commercial and investment banks that provide the rationale for their integration or otherwise. 3.1 Common premise for Commercial and Investment Banking Commercial and investment banks have a considerable level of commonality in their services so unifying them can prevent duplication and reduce the cost of operation. For instance, both commercial banks and investment banks engage in merchant banking and they most commonly invest in one type of security (common stock) as well as securities with an equity participation feature such as convertible preferred stock or subordinated debt with conversion privileges or warrants (Craig, n.d.). Regardless of how magnificent the hedge created by the separation appeared, there was a total collapse in this “wall” of separation after several decades Separating Commercial and Investment Banking 10 of its implementation as commercial banks created new financial products resembling securities, whiles investment banks innovated new financial products similar to loans and deposits (Jackson, 1987). Most financial analysts argue that the fusion of banking activities has not always proved beneficial for insurance companies and securities firms that purchased banks and commercial banks to underwrite insurance and securities (LaRoche, n.d.). It is in this regard that the UK's Independent Commission on Banking has espoused more radical reforms that could be geared towards capital provisioning (The Economic Times, 2011). With this suggestion, the underlying philosophy focuses on protecting commercial banks from their investment arms in order to limit taxpayer bailouts. 3.2 Unified Banking vs. Separated Banking In recent years, most of the debates over banking structure reforms have been directed towards reassessment of the provisions in the Glass-Steagall Act that mandated the separation of commercial and investment banking. Since the repeal of the Glass-Steagall Act in 1999 by the Gramm-Leach-Bliley Act, many banks have engaged in both commercial and investment banking activities, which is believed to have been a major contributing factor to the bust of the internet bubble in 2000 and 2001, and the beginning of the 2007-2008 global financial meltdown. At the most basic level, security investments (such as stocks and bonds) are liquid and publicly efficient for depositors and bond holders. This often makes many securities appear to be less risky than loans. But even if investing in securities is more risky than loans, Macey (1991, cited in Tabarrok, n.d.) argues that preventing banks from investing in securities could increase bank risk due to diversification benefits. Many are of the view that banks with security affiliates Separating Commercial and Investment Banking 11 (amalgamated banking) create an undue risk to depositors but Benson (1990, cited in Tabarrok, n.d.) disagrees to this assertion. According to Tabarrok (n.d.), “separated banking is riskier than unified banking.” This is in alignment with White’s (1986, cited in Tabarrok, n.d.) argument that banks without security affiliates are four times more likely to fail than those with security affiliates. While it is often argued that banks with security affiliates have conflicts of interest, unified banking supports investor interest more clearly than segregated banking because investors are able to threaten stronger punitive action if they invest with a unified bank than with a stand-alone investment bank (Benson, 1990; Saunders, 1985; Kelly, 1985, cited in Tabarrok, n.d.). In line with Benson’s (1990) evidence of fabricated records, Kroszner & Rajan (1994) found that the conflict of interest argument is contracted by investor behaviour because unified banks issue higher quality securities than stand-alone investment banks (cited in Tabarrok, n.d.). All these arguments support Randall Kroszner’s comment that “there was no evidence to back the “public interest rationale” for the separation of commercial and investment banking” (Mayer, 2009). In proposing to combine commercial and investment banking, many experts and practitioners in the global banking industry have made several counter-arguments that seek to relax the restrictions of the Glass-Steagall Act. Jackson (1987) outlines four cases that were made against preserving the Act. The first argument highlights how banks now operate in "deregulated" financial markets in which distinctions between loans, securities, and deposits are not well drawn; and how banks are losing market shares to unregulated securities firms and foreign financial institutions. T