Financial systems and development

Box 3.6 Universal banking
One of the most important trends in financial markets ers and trust and insurance companies to create large
in recent years has been the spread of "universal industrial trusts. Britain and France, after the failures
banking." This term has different meanings but usu- of the 1860s, were perhaps the only countries in which
ally refers to the combination of commercial banking the leading commercial banks specialized in deposit
(collecting deposits and making loans) and investment banking and short-term, self-liquidating lending. After
banking (issuing, underwriting, placing, and trading the Great Depression, commercial and investment
company securities). It also involves close links and banking were legally separated in the United States, K
extensive consultations between banks and industry. Canada, and several European countries-but not in
Universal banking has been criticized for threatening to Germany, Japan, and Britain (where functional special-,
concentrate excessive power among a few banks and ization continued to be based on tradition).
for introducing potential conflicts of interest. Adequate Universal banking began to spread again after the
regulation and supervision ought to overcome these mid-1960s. In Germany the large commercial banks are
difficulties, especially if securities markets and other actively involved in investment banking and in the
financial institutions are able to compete effectively. German stock exchanges. They provide both short-
Universal banking began in Belgium with the Soci6t6 and long-term debt finance to industry, hold equity in
Gen6rale de Belgique in 1822. Its initial impact was industry (although their equity holdings are concenrather
small, but it attracted considerable attention fol- trated in a few large companies), and exert a strong
lowing the creation of Cr6dit Mobilier in France in influence on corporate affairs. Swiss and Dutch banks
1852. By the 1860s similar institutions had been formed are similar, except that they do not hold direct equity
in Italy and Spain, but most of these ran into trouble. stakes in industrial companies. In Sweden, commercial
Universal banking was put on a more solid basis in banks are authorized to act as stockbrokers, but they
Germany when Deutsche Bank and Commerzbank are not allowed to hold equity except through holding
I were set up in 1870 to finance foreign trade. They were companies. In Belgium, holding companies such as the
i largely unaffected by the company failures in Germany Societ6 Gen6rale de Belgique have large equity stakes
before the international crisis of 1873, and after 1876 in both banks and industrial companies. Many industhey
gradually became universal banks with an exten- trial countries (for example, Belgium, Britain, Canada,
sive deposit business and close links to German France, and Greece) have reformed the membership
industry.
regulations of their stock exchanges to allow banks and
The German universal banks helped to establish other financial institutions to act as stockbrokers. In
many large industrial companies and presided over the recent years, universal banking practices have been
gradual concentration of industry in Germany. Their adopted by the large commercial banks in Britain and
expanding role in industrial finance coincided with France, which also have considerable interests in insurtechnological
advances that greatly increased their cli- ance business.
ents' capital requirements. With seats on supervisory In Japan, the zaibatsu groups were dismantled after
boards and proxy voting rights on behalf of individual World War II, and commercial and investment banking
shareholders (who deposited their shares with the were legally separated. Banks exert their influence
banks), they began to exercise tremendous influence. through the new industrial groups, and relations be-
Universal banking in Japan dates from the 1870s, tween banks and industry are close. Equity holdings
when traditional trading houses such as Mitsui were are limited, but Japanese financial practice gives debt
allowed to establish joint-stock banks. It increased in an equity-like role.
importance after the emergence of the zaibatsu con- The success of universal banking seems to reflect not
glomerates, which had extensive interests in industry, only the economies of scale and scope enjoyed by large -
commerce, banking, and finance. The zaibatsu banks and diversified financial institutions but also the imporbecame
more prominent after the 1920s-although tance of universal banks in monitoring corporate persome
of the most important banks of that period, such formance and controlling the behavior of corporate
as Yasuda (now Fuji) and Dai-lchi, had close links with managers. With the convergence of the world's finanvarious
zaibatsus without being formally incorporated cial systems, securities markets and institutional inveswith
them. tors have a bigger role in Germany and Japan, and
In the United States, state-chartered commercial commercial banks are becoming more involved in inbanks
operated as universal institutions along the lines vestment banking in Britain, Canada, Japan, and the
of German banks, underwriting and distributing cor- United States. Concerns about the concentration of
porate securities until the Great Depression. National power and conflicts of interest can be met by regulation
banks were prevented from engaging in investment and supervision-for example, by requiring that a
banking (although in 1927 they were allowed to under- separate subsidiary handle securities trading-and
1 write corporate securities on the same basis as state- by the development of securities markets and other
chartered banks). But by the turn of the century, the intermediaries.
big New York banks had combined with private bank-
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