Commercial banks emerge winners as securities firms go down

September 16th, 2008 - 11:03 pm ICT by IANS  

Lehman BrothersNew York, Sep 16 (IANS)In the banking industry’s biggest restructuring since the Great Depression, stand-alone securities firms such as Lehman, Merrill and the now-defunct Bear Stearns are on the wane, giving way to more old-fashioned commercial banks which chase customer deposits and build branch networks.Of the five major independent investment banks that existed a year ago, only two - Goldman Sachs and Morgan Stanley - remain standing.

Two others, Merrill and Bear Stearns, have been acquired by big deposit-taking institutions, Bank of America and J.P. Morgan Chase.

Other giant commercial-banking players, such as Wells Fargo in the US, as well as Germany’s Deutsche Bank AG and Spain’s Banco Santander SA, have emerged as some of the most powerful players in the financial industry that is likely to be safer but less lucrative for shareholders, Wall Street Journal reported Tuesday.

The world of banking was divided for decades largely into two kinds of businesses.

Commercial banks took deposits and made loans, making a decent return under the burden of heavy regulations designed to protect depositors.

Securities firms took no deposits and were lightly regulated, which let them take big risks and rake in big profits - and occasional losses. More recently, some of the biggest institutions, such as Citigroup and UBS AG, combined both businesses.

Now, as many securities firms are falling following ‘financial wizardry’, the balance of power is shifting.

Banks are heading “back to basics - to, if you like, the core purpose of the system with less bells and whistles,” Douglas Flint, finance chief at HSBC Holdings PLC and co-chair of the Counterparty Risk Management Policy Group, told the Journal.

“There is a recognition that when the dust settles… the construct of the industry will be different,” he said.

Evidence of the new importance of basic banking can be seen around the globe.

Deutsche Bank, which had remained focused on building its global investment-banking business, last week agreed to acquire for $4.3 billion the 850 domestic branches of Deutsche Postbank AG, the retail banking arm of the German postal system.

The shift reflects a reassessment of the best way to do the essential business of banking, by turning short-term liabilities - savers’ cash and deposits - into longer-term investments such as mortgages and corporate loans.

Commercial banks have been moving a lot of that business off their heavily regulated balance sheets into the realm of securities firms, the Journal said.

The investment banks packaged the loans into a variety of more complex securities, which they kept on their books or sold to a broad range of investors - including hedge funds and bank-affiliated funds known as conduits and structured-investment vehicles (SIVs).

To fund their activities, the securities firms and investors borrowed heavily in the commercial-paper market and the so-called repo market, where borrowers put up securities as collateral for short-term loans.

Their strategies, however, backfired with the onset of the credit crunch over a year ago.

The bankruptcy filing by Lehman Brothers on Monday in New York followed their May end repo loans to the tune of $188 billion.

But as the value of the securities Lehman had put up as collateral for the loans fell amid the broader market turmoil, its lenders started demanding extra collateral.

As Lehman was forced to dip ever deeper into its cash reserves, ratings firms cut its credit ratings, according to the company’s filing.

An important landmark for the banking industry in the US was the repeal in 1999 of a Depression-era law preventing US commercial banks from venturing into investment-banking.

It allowed commercial banks to break into the securities business and gain the wherewithal to compete with the likes of Bear Stearns and Merrill Lynch.

This banking model too has proved hard to manage, with the likes of Citigroup and UBS knitting together vast empires of operating units.

But these two and other big deposit-taking banks such as Bank of America, that are required by federal regulators to maintain bigger cushions against losses, have so far survived the credit crunch better than some of the stand-alone securities firms, the Journal said.

Deposits have seen an upward swing despite the credit crunch. In the US, savings and small time deposits rose 7.6 percent over the past year to stand at $6.9 trillion at the end of August. In the euro area, deposits rose 12.8 percent over the year ending July.

Not all stand-alone investment banks are in danger. Goldman Sachs, for example, is well funded. Consumer debts such as mortgages, credit-card balances and student loans will still be packaged into securities.

Some innovations and markets will rebound when the credit crunch fades, the Journal concluded.

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