Commercial bank vs Investment Bank By Jee Eun Kwak

※ Commercial Banks or by the federal government (national banks) ■ Banks are charted by the state (state-chartered banks) or by the federal government (national banks) ■ National banks must be  members of the Federal Reserve System. (not for state-charted banks) ■ All banks must be insured by  the Bank Insurance Fund (BIF)

 How bank can generate income? Bank Services  How bank can generate income? Interest Spread Savers - Households - Business Firms - Government - Foreigners Loan Borrowers - Business firms - Government - Households - Foreigners Deposit Commercial Banks Interest Interest ` Financial Market

 How bank can generate income? Bank Services  How bank can generate income? ■ Interest & Fee income from… (1) Individual Banking (2) Institutional Banking (3) Global Banking - Corporate financing (funds, advice strategies) - Capital market / Foreign exchange products & svcs. : gains from securities or foreign currency transactions

 How bank can raise fund? 2. Bank Funding  How bank can raise fund? (1) Deposits (2) Nondeposit borrowing - Reserve requirements - Borrowing in the Federal Market (3) Common stock and retained earnings

3. Regulation (1) Regulation of Interest Rates Supervised by Federal and state government entities (Federal Reserve Board, the Office of the Comptroller of the currency, Federal Deposit Insurance Corporation) (1) Regulation of Interest Rates : Ceilings imposed on the interest rate that can be paid on deposit accounts (o) Regulation Q (x) Depository Institutions Deregulation and Monetary Control Act (1980) (-) Gran-St.Germain Act (1982)

■ Riegle-Neal Interstate Banking and Branching Efficiency Act 3. Regulation (2) Geographical Restrictions ■ McFadden Act of 1927 :restriction on intrastate branch banking  prevent expansion of large banks, protect smaller banking entities ■ Riegle-Neal Interstate Banking and Branching Efficiency Act :Permit bank holding companies to acquire banks in any state approved by the Federal Reserve Permit interstate mergers between banks (from 1997)

3. Regulation (3) Permissible Activities for Commercial Banks (sweeping legislation in bank regulation and change in bank’s activities) ■ Glass-Steagall Act. 1933 : Limit business of dealing in securities and stock, insurance area ■ Gramm-Leach-Bliley Act 1999 : Erode the barriers against commercial banks’ engagement in investment banking activities

3. Regulation (5) Federal Deposit Insurance (4) Capital Requirements for Commercial Banks 1. Capital consists of equity and dept 2. Risk-based capital requirements - Prior to 1989, solely considered the total assets. - 1989, Federal Reserve adopted guidelines for capital adequacy based on the credit risk of assets. - Capital: core capital, supplementary capital (5) Federal Deposit Insurance >> Federal Deposit Insurance Corporation - Panic & failure of banks in 1930s, - The government created insurance to protect.

3. Regulation (6) Federal Deposit Insurance ※ Capital consists of equity and dept ■ Risk-based capital requirements - Prior to 1989, solely considered the total assets. - 1989, Federal Reserve adopted guidelines for capital adequacy based on the credit risk of assets. - Capital: core capital, supplementary capital

Securities, Strategic Advisory ※ Investment Bank ■ No deposits ■ Assist institutions obtaining the funds ■ Act a broker or dealers in buying & selling securities Investment Banks Buyers - Households - Business Firms - Government - Foreigners Sellers - Business firms Securities, Strategic Advisory F u n d s

public offering (underwriting) of securities Activities 1. public offering (underwriting) of securities 1. Advisor role (Design securities structures) : Advising the issuer on the terms and the timing of the offering 2. Buying the securities from the issuer 3. Distributing the issue to the public

Activities 2. Trading of securities Bid-ask spread :difference between paid & selling price of the securities 2. Appreciation of the price of the securities (inventory) Activities 3. Private Placement of Securities Place securities with a limited institutional investors (insurance companies, investment companies, pension funds…) 2. Assists in the private placement of securities

Activities 4. Securitization of assets ■ Issuance of securities using a pool of assets as collateral : Mortgage-backed securities, Asset- backed securities - Securitize a wide range of loans and receivables - Buy loans & receivables and issue securities backed by them  Generate revenue from the bid-ask spread in sales of securities Profit from asset-backed security transaction (difference between the purchase & price sold)

Activities 5. Mergers & Acquisitions Advisory Services ** Leveraged buyouts (LBO) acquiring a firm using mostly debt funds and taken private. Activities 6. Merchant Banking Place securities with a limited institutional investors (insurance companies, investment companies, pension funds…) 2. Assists in the private placement of securities

Activities 7. Trading and creation of derivative instruments Activities 8. Money Management : manage funds for either individual investors or institutional investors (pension funds)

Investment banks need tougher regulation?