The Role of Investment Banking in the Us Financial System

Introduction to Investment Banks The roots of investment banks are varied. Some are bankers or merchants who started guaranteeing other merchants' bills, others are outgrown brokerages, but most are products of the Glass-Steagall Act. Originally, the term "investment bank" comes from the United States of America, while some other variations include ‘merchant bank' in the United Kingdom and ‘securities house' in Japan. With the globalization of US investment banking, the term has become a generic concept, nonetheless, while in the USA merchant bank has come to mean a bank which risks its own capital in bridge loans and position taking. Small, limited-function investment banks are called ‘boutiques'. They thrive on relationships and the quality of work rather than committing their own capital, and necessarily lose the attached income. From today's perspective, the Glass-Steagall Act may appear a deplorable market imperfection. For the investment banks, it was a godsend for the reason that it protected their independence from the money-center banks for decades. Moreover, it also gave them the first-comer advantage internationally. They were free to underwrite equity and debt issues, trade them, arrange mergers and acquisitions, provide bridge loans for buyouts (LBOs and MBOs), develop products, hone skills and gain strength domestically. By the time international capital markets opened, they were the best and, backed by a home market which still generates two-thirds of investment bank revenue worldwide, went from victory to victory. Entrenched domestic banks, often much smaller but with all possible connections, could not outsmart the American banks which were selective and expensive, but got deals done. While the letter of the law separated commercial and investment banks, the profound difference was and is cultural. A typical commercial bank thinks nationally, has an extensive branch network supported by largely captive customers, staffed by

Cited: Caims, AJ, Davidson, JA, Kisilevitz, ML 2002, The Limits of Bank Convergence: Don 't Bet the Bank on the Idea That Investment Banks Can Survive the Current Market Only If They Merge with Commercial Ones, The McKinsey Quarterly, p. 41+. Forsyth, DJ & Verdier, D (ed) 2002, The Origins of National Financial Systems: Alexander Gerschenkron Reconsidered, Routledge, New York. Matthews, JO 1994, Struggle and Survival on Wall Street: The Economics of Competition among Securities Firms, Oxford University Press, New York.