In the situation of classic deposit and loan banking, the bank's equity translates into the bank's ability to engage in active operations, which include, above all, loans, paracrine instruments and investments in securities. In classical banking, deposit and credit, the funds deposited in deposits determine the opportunities for the development of lending. If a commercial bank operating in the classical deposit and credit banking model also develops investment banking activities, then the risk management process should include quantification of risks related to the bank's involvement in investment activities for particular types of assets, including investments in securities, derivatives and other assets that generate high credit risk. Investment banking should have appropriately higher specific provisions to cover high levels of estimated risk in order to reduce the likelihood of loss of liquidity and announcements bankrupt in a situation of a downturn in the domestic economy and markets where the bank's contractors and clients operate.
I invite you to the discussion
In view of the above, I am asking you the following question: What happens when a deposit and credit bank becomes involved in investment banking activities?
Please, answer, comments. I invite you to the discussion.
One of the key reason of 1929 great depression was involvement of deposit & credit banks in investment banking activities. Deposits were channeled to corporate bonds and during economic slowdown most of the depositors lost their money.
Core banking and investment banking activities were then separated under Glass-Steagall Act which was in force till 1999. Investment banking activities were reallowed under Graham-Leach Act.
Core banking and IB activities should be taken together under ethical responsibility. Strong self as well as government regulations are must with risk management system being regularly monitored.
think one should also look at proportions.
banks also have VC, etc arms, but these are never really a big proportion of overall business operations.
so, if banks start to operate in investment banking, what proportion of overall business would this constitute, particularly at startup, and is it therefore significant?
The basic issue is Investment Banking is different from General Banking, so staff competencies may be an issue. But there could be different verticals, and competent professionals can be brought on board. The other is the ALM issues. Generally banks do not have long term funds. This can be judiciously managed by setting exposure limits. The high risk area is to fund long term Infrastructure projects. That would be risky.
One of the key reason of 1929 great depression was involvement of deposit & credit banks in investment banking activities. Deposits were channeled to corporate bonds and during economic slowdown most of the depositors lost their money.
Core banking and investment banking activities were then separated under Glass-Steagall Act which was in force till 1999. Investment banking activities were reallowed under Graham-Leach Act.
Core banking and IB activities should be taken together under ethical responsibility. Strong self as well as government regulations are must with risk management system being regularly monitored.
Basel II & III norms covers provisions of capital requirements for risk associated with investments in securities, derivatives and other assets that generate high credit risk.
Prof. Prokopowicz,
In terms of our research into Incomplete Financial Markets (for e.g. Mallick (2002)) and in terms of my PhD dissertation at NYU (Mallick (1993)) on www , and research in this field by Geanokoplos & Polemarchakis, Polemarchakis & Siconolfi, Polemarchakis & Ku, Polmarchakis & Dutta, Werner, Grossman & Hart, Wilson and others and also based on my research relating Incomplete Markets to Financial Institutions like Commercial Banking, I can say that if markets are complete asset prices in competitive efficient markets and interest rates will at equilibrium in the long run ensure that loans and investment prices will be such that it does not matter whether the Banking companies are operating through loans and deposits or investment banking. Both operations systems will give the same decisions and efficiencies. The problems arise because asset markets are incomplete in the presence of inequality and information assymmetries as wehave investigated. Therefore in such empirical situations the two types of businessses will give different results and the question will depend upon amongst other factors how good the information learning system of the prospective bank is with respect to the two types of undertakings and hence the decisions will be cost benefit justified accordingly.
S.K.Mallick
for RHMHM School
Clearly there is a risk of Asset Liability mismatches leading to a liquidity risk.
The collapse or near collapse of banks in the UK that did that (2008?) is testimony to the problems. Bailed out by western governments the alternative was severe impact on the nation's economy. They do tend to forget that its not actually their money they are playing with.
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