GRI research project

Business Enterprise Environment

Sneh Shah

Dr. Seaman

NYIT School of Management

Summer 2015

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Financial industry of United States has the capability to speed the economy of the country and

also has the potential to destroy the economy. Major economy downwards in United States has

happened due to the failure of financial industries. In that investment banking and the

commercial banking are the key player of any financial industries in the world. Investment

banking is the backbone of the financial industry. Recession of 2008 has been happened due to

the improper mortgage allotment in housing industry. Investment banking had the major role of

allotment of the mortgage in realtor industry. Invest banks helped to create the bubble in housing

market. Investment banking acts as the agent in trading the financial securities like stocks and

bonds. Investment banking helps to expand capital market.

What Investment banks do?

1. Initial public offering – Investment banks play the major role in distributing IPO of any

company to the public. At first company who wants to go for public trading goes to the

Investment banks and investment banks take the part of the share of the company. Now

Investment banks decide the price of the share and then banks distribute the shares in

public (Lohse, 1997).

2. Investment – Investment bank gives the advice to the issuer of the share and other money

market securities and also gives the advice to the investors about investing money in

stocks, bonds and other securities called hedge funds. Investment banks also provide the

advice for mutual funds and on real estate industry to investors. Investment banks get the

commission by performing these functions (Bodnaruk, 2009).

3. Mergers and Acquisition – Investment bank also helps to do merging or the acquisition

between two companies. Investment banks act as a broker between two companies and

help in negotiation and also help in finding the group of bidders who are willing to do

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merging or acquisition. Nowadays, Investment banks do the market research and publish

the report on company review for buying or selling. These kind of reports help in M&A.

These days, companies are using these reports but they do not use the investment bank

service a broker for M&A (Elstein, 1999).

4. Role in secondary market – All kind of market equities are traded in secondary market

via investment banks. Investment banks set the price for the buyers and for the sellers.

Price for bidders and sellers are different. By doing this practice the fair value for equity

can be known and trading would be done easily. This whole process is described as the

market making process.

5. Structure Financing – This is the most complicated and riskier financing process.

Sometimes the loan is not sufficient for the borrowers to satisfy their financial needs so

they will go to the investment banks to borrow money under the name of complex

securities like collateralize bond, debt or mortgage obligations. Structure financing has

made possible to borrow the large amount of money for the big projects like

constructions (Jobst, 2005).

Investment banks also indulge themselves in merchant banking and in managing the risk by

giving the good credit or bad credit to traders.

Regulatory bodies for Investment banking

In United States, rules and regulations for investment banking are governed by the three

major government departments.

1) Federal Deposit Insurance Corporation (FDIC) – FDIC is responsible to deposit

insurance for the security of each account holder of independent banks of United States.

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If any bank goes in bankruptcy, it will be FDIC responsibility to protect account

depositors. FDIC also inspects different financial firms in terms of the security and

safety.

2) Federal Reserve board – Federal Reserve board has twelve Federal Reserve banks in

twelve different stats of United States. These banks are for regulating the activities of

commercial banks as well as investment banks. Federal Reserve banks are also

responsible for regulating the flow of money in financial market. They have the ability to

print money.

3) National credit union administration (NCUA) – This independent government body is

responsible for the supervision of credit unions of United States. Insurance fund and other

mutual fund regulations are closely monitored by NCUA. Credit unions are regulated and

chartered by NCUA.

List of five major regulations

Investment banking has the major impact by five important regulations. These five

regulations have changed the banking system.

1. Banking act of 1933

2. International banking act of 1978

3. Riegle Neal interstate banking act of 1994

4. Gramm Leach Bliley Act of 1999

5. Volcker rule of 2014

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1. Banking act of 1933

Banking act 1933 is also known as the Glass Steagall act. This act was proposed by two people

named 1) Carter Glass and 2) Henry Steagall. This act was formed to overcome from the great

depression which was occurred in 1929. This act was making the restriction to merge

commercial banks and investment banks together. It means financial banks could either act as the

commercial bank or as the investment bank.

Investment banking became in focus due to four main points of glass steagle act

1. Commercial banks cannot trade any money market securities for public

2. Commercial banks were restricted to invest in securities for commercial banks

themselves.

3. Commercial banks were prohibited to buy any shares for clients. It means no

underwriting.

4. Commercial banks cannot make partnership with other organizations those are

responsible for trading financial securities.

These restrictions have made the investment banking as a separate financial industry.

Situation was created for banks to choose one of the streams for doing banking. One was

to be a commercial bank and other was to be an Investment bank. Classic example is JP

Morgan Corporation. JP Morgan Company had decided to be the commercial bank rather

than the investment bank. One of the employees of JP Morgan Company was not happy

and he had decided to make his own investment bank. This Investment bank is known as

Morgan Stanley.

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Effect of Glass Steagall act on investment banking

1. Banks were playing both the role as investment bank or as the commercial bank.

They need to abandon the one of their role so there was the loss of banks.

2. Banks had to lose the competitive advantage against other banks in foreign countries

and especially against European countries.

3. Competition between commercial banking was increased and forced to take the risky

steps to increase the profit against other commercial banks.

Glass Steagall act was considered as not a right act for the modern world with globalization.

Because of this act there was the government interference in some extend. Completely opposite

act was structured in 1999 under the name of Gramm-Leach-Bliley Act.

2. International Banking act 1978 (James R. Barthy, 2009)

International banking act was made to restrict the foreign banks from being one of the

biggest banks in United States. Local banks were able to open as many branch as they

can in home state only but they are not able to open offices in other states of USA.

Foreign banks had the advantage for opening as many offices they want in all over

United States. Regulations of local banks were not implemented on foreign banks.

Because of this unique advantage of foreign banks, they were inflated in all over United

State. Local investment banks were lagging behind from foreign investment banks.

There were two main provisions which have brought local investment banks in

competition.

Foreign banks will be treated same as the local banks and they have to select one

home state for the office. Now there was no more advantage of being foreign

bank. Foreign investment banks and local investment banks were treated equally.

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Foreign banks were needed to deposit the insurance as a security to FDIC. This

was as security for depositors.

Impact of international banking act of 1978 (Skigen & Fitzsimmons, 1979)

1. Foreign banks had no more competitive advantage after this rule.

2. The tension was created for the local banks those had the foreign branches.

There was the possibility that foreign countries might not treat well.

3. Riegle-Neal interstate banking act of 1994

Riegle Neal interstate banking was in from September 1994. This act was the replacement of

Mc- fadden act. This was implemented in two different years. Half of the act was implemented in

1994. In 1994, restriction of acquiring bank in interstate was taken out. Any bank in United

States has the right to acquire any bank even if the bank is not in the same state. After making

this as a rule, 1997 was the year to implement the whole Riegle Neal interstate banking act. Now

bank has the right to open its own branch in any state of United State. Now bank can acquire any

bank and can open it as the branch in United States.

Impact of Riegle-Neal Act on Investment banking (DeYoung et al., 2004)

Merging of financial sectors had become easy. There were no geographic restriction in merging

and acquisition. It has benefited to big financial banks. Investment banks and commercial banks

had the advantage of expanding. Investment banking was in its golden era. Merger and

acquisition do need the investment banking as a broker between two commercial banks and also

had the opportunity to do merging with another investment bank also. They were gaining the

profit from both the side.

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Commercial banks and Investment banks were becoming big firms by merging with each other.

Restriction of government was very less.

The impact of Riegle and Neal act had become double when the implementation of Gramm-

Leach-Bliley Act of 1999 was occurred. Whole structure of financial industry was changed

because of these two acts. These acts are also called as the cause of 2008 recession t (Barth

et al., 1996).

4. Gramm Leach Bliley Act of 1999

Gramm leach Bliley act is also known as Financial Services Modernization act. This act is

completely opposite of Glass Steagall act. Glass Steagall act was completely taken out from the

legislation by implementing GLB act. That time president of United States was Bill Clinton. He

also made the announcement that Glass Steagall act is not good for United States’ economy so

now there is no more Glass Steagall act (Gaviria, 2012). Glass steagall was responsible for

making investment banking and commercial banking as the separate financial industries. After

GLB act everything was changed. There was no longer restriction from merging with each other.

For instance, Commercial banks can merge with investment banks easily. It is said that this act

was passed because of the globalization. Foreign banks had no restriction like acting as

commercial bank or the investment bank. They can play both roles. Before GLB act, Local US

banks had to be either the commercial bank or the investment bank. To vanish this competitive

advantage GLB act was passed.

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Explanation of Gramm leach Bliley act

This act was for removing all the restrictions of financial industries. There were no more

different segments like investment banks and commercial banks. Commercial banks had no

restriction in buying securities for themselves as well as for clients. Commercial banks could act

as the investment banks and investment banks could act as commercial banks. They can also sell

insurance or can acquire the insurance company.

Effect of Gramm Leach Bliley act

City bank and travel insurance merged together and made world’s largest financial

company. They were having the asset of $700 billion. Even JP Morgan and Chase bank

merged together to become United States’ number one bank in size.

Because of merging financial banks had become larger and larger. They were having lots

of money in hand. They have used this money to lend mortgage in housing industry. By

giving mortgage, banks were expecting to get lot more interest rate on it. But I reality

housing bubble was created. When the bubble was burst, all financial banks were in debt.

Steps to improve this act

1. Commercial banks and investment banks should be separated by

implementing glass steagall act.

2. These firms had become too large to handle so it is necessary to cancel the

merging of big financial firms like JP Morgan and chase or city bank and

travelers insurance. This step is difficult to implement but it will have the

immediate effect on financial industry.

5. Volcker rule of 2014

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Volcker rule was implemented by Obama government. This rule was first proposed in 2009 by

Paul Volcker. This rule is passed under the dodd frank act of 2010. This act was made to

alleviate the effect of 2008 recession.

Explanation of Volcker rule (Taylor, 2010)

Volcker rule can be explained in two steps.

1) First is to repealed the effect of Riegle neal act. According to this act if merging can

happened between two financial industries, it should not acquire more than 10 % of

national deposits at FDIC. For instance, City bank and JP Morgan chase corporation will

merge then national deposits of both the company would be more than 10

%. In result, they cannot be merged by law.

2) Secondly proprietary trading was restricted. That means investment bank cannot practice

proprietary trading. Investment bank cannot trade securities for the betterment of itself. It

cannot take money of customer to invest for gaining the profit for its own company. Risk

factor was reduced by implementing Volcker rule.

Effect of Volcker rule

Investment banks are not happy because of the restriction in proprietary trading.

Proprietary trading was one of the profit tools for investment banks. Because of

this profit margin is reduced.

10% cap is worthless.

Modification in Volcker rule

There is the need of modification in Volcker rule

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Merging between two financial companies should be restricted. Even small merge

can cause the big impact so no merging is the great idea.

Conclusion

Obama government has brought up Volcker rule but it is not enough to restrict another

recession in unite states. Merging of commercial banks and investment banks should be

prohibited. Even big companies like JP Morgan and city bank should be restricted to

expand their company in future. Because more money they would have, there will be more

chances to put that money in risk to gain the profit. Here too big to fail theory is in effect

so merging should be restricted. Glass steagall act was good for the United States

economy. Riegle-Neal interstate banking act of 1994 and Gramm Leach Bliley Act of

1999 were the cause of the great recession in 2008. So all rules of these two acts should be

revised for stable economy

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References

Barth, J.R., P.A.V.B. Swamy, R.Y. Chou and J.S. Jahera, Jr. (1996), ‘‘Determinants of U.S.

Commercial Bank Performance: Regulatory and Econometric Issues’’, in A.H. Chen and K.C.

Chan, eds., Research in Finance, Vol. 14, JAI Press Inc., Greenwich, England.

Bodnaruk, A., Massa, M., & Simonov, A. (2009). Investment banks as insiders and the market

for corporate control. The Review of Financial Studies, 22(12), 4989. Retrieved from

http://search.proquest.com/docview/230058641?accountid=12917

DeYoung, R., W.C. Hunter and G.F. Udell (2004), ‘‘The Past, Present, and Probable Future for

Community Banks’’, Journal of Financial Services Research 25, 85–133.

D. L. (1997, Nov 17). IPO market (A special report): IPO market still cooking, but with a lack

of sizzle. Wall Street JournalRetrieved from http://search.proquest.com/docview/398772871?

accountid=12917

Elstein, A. (1999, Jan 14). Investment banks tally fees, lose prestige in deal wave once

confidants, M&A bankers focus on selling. American Banker Retrieved from

http://search.proquest.com/docview/249802599?accountid=12917

James R. Barthy, T. L. (2009). Bank Regulation in the United States. CESifo Economic Studies

Advance Access, 1-29.

Jobst, A. A. (2005). WHAT IS STRUCTURED FINANCE ? . finance and development.

Lohse, D. (1997). IPO Market (A Special Report): IPO Market Still Cooking, But With a Lack of

Sizzle. wall street journal, c1.

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Skigen, P. S., & Fitzsimmons, J. D. (1979). The impact of the international banking act of 1978

on foreign banks and their domestic and foreign affiliates. The Business Lawyer, 35(1), 55.

Retrieved from http://search.proquest.com/docview/228455154?accountid=12917

Taylor, M. (2010). The volcker rule: Wrong answer or the right question? Central

Banking, 20(4), 15-19. Retrieved from http://search.proquest.com/docview/743832080?

accountid=12917

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