Evolutionary History and Structural Patterns of Investment Banks in the United States
From the perspective of the relationship between investment banks and commercial banks, the development history of investment banks in the
United States was punctuated by the separation, integration, reseparation and reintegration of investment banks and commercial banks, which is the American way of investment bank development. These four phases are detailed here:
1. The first phase: Natural separation phase. Investment banks first appeared in the United States in the beginning of the nineteeth century. The investment bank and the commercial bank were independent of one another, each with its own well-defined business scope. Investment banks mainly engaged in securities underwriting. Commercial banks mostly engaged in deposits, loans, and other types of credit business. In this phase, the separation of investment banks and commercial banks was a natural result of historical and economic development, rather than something created by law or statute.
2. The second phase: "Early mixed operation" phase. With the development of the domestic economy in the United States, the capital market also grew bigger. In the late nineteeth century and early twentieth century, direct financing gradually took center stage in the development of the financial industry, which had been previously occupied by indirect financing. The shift was manifested in unprecedented active investment, speculation, underwriting, and brokering activities in the securities market. The development of the securities market expanded financing channels for enterprises and brought in a large amount of direct financing. Favorable returns from the securities market also caused enterprises and investors to transfer their capital from banks to the securities market. In the face of a capital drain that severely challenged their traditional business, commercial banks started making great effort to get into the investment banking business, drawing on their great capital strength. This transformation was convenient partly due to the fact that fewer legal barriers existed at that time. The competition for turf between investment banks and commercial banks during that time essentially led to the final integration of the "two industries."
3. The third phase: Post-depression "modern separation" phase. After over a decade of prosperity, the U.S. stock market plummeted in 1929 to trigger the Great Depression. The "mixing" of securities and banking was considered by many to be the root cause of the crisis. As the result of "mixed" operation, money could easily flow into the stock market and create bubbles. When the bubbles burst, the stock market collapsed and finally led to the complete collapse of the economy. In order to protect the safe development of commercial banks and avoid similar crises from happening again, the United States passed the famous Glass-Steagall Act in 1933, which clearly defined the business scope of commercial banks and investment banks for the first time. This brought to an end to the era of mixed operation of investment banks and commercial banks in the United States, and established the separate operation model. After the Second World War, many countries including the United Kingdom and Japan followed in the footsteps of the United States and enforced separate operation for investment banks and commercial banks. 4. The fourth phase: "Modern mixing" phase. In the 1980s, mixed operation once again became the development trend of investment banks, fueled by a new round of technological revolution, financial innovation and liberalization, and financial globalization. In dealing with internal and external competition, investment banks and commercial banks made attempts to dodge the Glass-Steagall Act in order to expand their business share. From the perspective of the regulators, in order to secure the status of the United States as the center of the global financial market and maintain the global competitiveness of U.S. financial institutions, a series of liberalization measures needed to be taken to promote the development of the financial industry. During the period from the late 1970s to the late 1990s, relevant laws and regulations were made or revised to relax restrictions on mixed operation. For example, the interpretation of the Securities Law was loosened in 1977. Restrictions on the underwriting of commercial papers and corporate bonds by commercial banks were loosened in 1978. The Deregulation Act was passed in 1980. In 1987, some commercial bank holding companies were allowed to engage in securities business through their subsidiaries. In 1989, commercial banks were allowed to underwrite corporate bonds. In 1991, the U.S. Department of Treasury promulgated the Federal Deposit Insurance Corporation Improvement Act of 1991, which allowed some banks to acquire and hold common shares or preferred shares to an amount equal to 100 percent of their capital. In 1999, the U.S. Congress passed the Financial Service Modernization Act, which officially abolished the symbol of the separate operation system, the Glass-Steagall Act, putting the finishing touch on the shift from "separate" operation to "mixed" operation. In 2008, marked by the bankruptcy or merger of the five biggest U.S. investment banks in the face of the international financial crisis, major investment banks in the United States transformed into bank holding companies, ushering in an era of full-on mixed operation.
The following two major development models are identifiable in the development history of investment banks in the United States: The Merrill Lynch model and the Citigroup model.