Three Cheers to the Universal Bank!
The Glass-Steagall Act was enacted in response to the Crash of 1929. Large, deposit-holding commercial banks had waded into the booming stock market, underwriting issues and making risky loans (sounds familiar?). When the market crashed and banks failed, deposits were wiped out (there was no FDIC, back then!), kick-starting the Great Depression.
Regulatory approval for the Citigroup merger was a harbinger to the repeal of Glass-Steagall; commercial banks wanted a piece of the booming stock market of the late 1990s. The Gramm-Leach-Bliley Act of 1999 marked the official repeal, allowing commercial banks to own investment banks and vice versa.
Until recently, the Universal Banking trend has been somewhat slow to catch on. JPMorgan Chase was formed in 2000, capping a series of acquisitions and mergers, establishing (before last Sunday the 14th of September) the only other large U.S. Universal Bank. Why? Large, bulge-bracket investment banks had been incredibly successful prior to the onset of the credit crisis, a year back. High stock prices scared away potential commercial bank suitors and the wildly successful investment banks didn’t feel the need to take on a commercial bank. Further, in the early months of the credit crisis, large Universal Banks like Citi and UBS came under fire, ostensibly for not being able to manage the complexity of their distinct lines of business.
As we have all learned, rather painfully, a lot can change in a weekend. Independent investment banks are increasingly strapped for cash and collateral, due to the risky bets they have made and merging with a deposit-rich commercial bank appears to be one of the few viable ways to avoid bankruptcy. For many commercial banks, this is an opportunity to add the missing piece of the puzzle: instant investment banking credibility, along with access to high-net worth clientele and top-tier investment banking talent. As I am writing this, I notice a breaking news item about Citi hiring Lehman Brothers’ Head of M&A in a similar capacity at its investment bank!
The quick fire merger between Merrill Lynch and Bank of America is a prime example of this. After years of trying, rather unsuccessfully, to build an in-house investment banking division, Bank of America paid a significant premium for arguably, one of the most recognizable investment banking brands in the world!
Although some questions on the viability of large Universal Banks do persist, the potential synergies are worth a second look. Deposits create a secure base for investment banking activities, along with better opportunities for cross-selling with a one-stop-shop approach. Additionally, middle and back office economies-of-scale offer considerable cost savings. Perhaps most significantly, Universal Banks are positioned to take control of what will likely be the most lucrative piece of the financial sector pie - Wealth Management.
I know what you are thinking. What prevents another Crash of 1929 situation, where out-of-control Universal Banks begin to fail? Stronger, more comprehensive regulation surely does help and despite suffering considerable mortgage-related losses, both Citi and JPMorgan Chase remain in relatively good shape. The modern Universal Bank also has access to a broader range of fundraising activities, making it easier to raise capital in tough times. However, as with any entity, the success of modern Universal Banks depends mostly on successful management as opposed to mere regulation. Strong leadership and well thought-out risk mitigation strategies will determine the success of the Universal Banking movement.
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Just after I posted this, on late Sunday (September 21st) night, Goldman Sachs and Morgan Stanley, the last two independent investment banks on the Street, decided to turn themselves into full fledged bank holding companies - read here! So the Glass Steagall Act era truly ends today!
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I look forward to your comments, even as the Financial World around us is going through a tectonic shift!
Comments
Is it good for a customer like you and me ? I don't think so; customers will be thrusted upon with all other products and their other businesses.It will be a separate post; if we look at the history.
Posted by: Kannan | September 19, 2008 7:33 PM
Well, Investment banks and commercial banks under one umbrella sound lucrative. Since this crisis has proved that financial re-engineering can create havoc. The MBS were created on weak underlying assets and further to play safe, CDS were created on MBS and CDO’s using CDS. It’s clear that it was a cascaded reaction and has shown how deregulation can bring turmoil in the market.
As a reply to slow growth in economy, Alan Greenspan lowered interest rate and lenders in an attempt to raise profit started selling these to Mortgage giants Fred and Fannie.
World will see a change in structured products which gives high return. The investment used financial re-engineering to design such products, now with these banks getting into commercial bank premises will start a new era of finance.
The deposits in Commercial banks are regulated and are insured by Fed and to create any product does not seem feasible. But yes, it will diversify the portfolio and increase the customer reach. In fact because of this Josef Ackerman, CEO of Deutsche Bank, acquired 24% stake in Deutsche Post Bank.
Whatever the outcome is, but I feel, it will give a relief to Indian IT companies who are already handling Goldman Sachs and Morgan Stanley. Because, moulding into commercial banks will impose more regulations and provide greater access to funds. This could result in changing existing software and processes. They would require launching retail banking, consumer banking, credit cards and corporate banking.
Posted by: Amit Mehndiratta | September 23, 2008 10:31 AM
In a universal bank, the losses of one business are hidden by other stronger businesses of the banks. While universal banking is the way to go, there is no substitution for some amount of stronger regulation to reign in the excesses.
Posted by: Sumedh Rajadhyax | October 1, 2008 5:25 AM