Securities underwriting by commercial banks : an analysis of Section 20 subsidiaries

Abstract

This study examines the wealth and risk changes of commercial banks following regulatory changes related to securities underwriting. Commercials banks were allowed to underwrite securities to a limited extent by a Federal Reserve ruling of April 30, 1987. Securities underwriting by commercial banks had previously been prohibited by the GlassSteagall Act of 1933. Underwriting trends of commercial banks are examined by analyzing the various issues underwritten by commercial banks. Results indicate that commercial banks have captured a significant share of the corporate debt and asset backed securities markets. Banks also show a preference for underwriting corporate debt and equity over asset and mortgage backed securities. The Seemingly Unrelated Regressions (SUR) methodology was used to measure changes in wealth and systematic risk. Results revealed that commercial banks gained in value and experienced diversification benefits following their entry into underwriting. Subsequent court cases related to the Federal Reserve ruling of April 30, 1987 did not significantly impact the risk or return of banks. Banks experienced a decline in value and increase in risk following their entry into corporate debt and equity underwriting. This would indicate that increase in revenue from expanded underwriting powers was not sufficient to offset the additional risk. The study found a decrease in wealth of both commercial and investment banks following an increase in the ceiling on revenues from underwriting activity. The wealth effects were more pronounced for money center banks, who also experienced an increase in risk significantly greater than by non-money center banks. Individual banks with underwriting powers were also examined around the submission and approval dates of their applications seeking underwriting powers. Results indicate no systematic change in wealth or risk for domestic or foreign banks. At a time when the Congress is contemplating a partial, if not the full repeal of Glass-Steagall the results have significant implications for regulatory policy. Results suggest limited benefits to diversification. A further examination of issues underwritten by banks would provide a clearer picture of their risk characteristics.