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Old Money: US banks — masters of the universal banking model

Death Star Star Wars

Recent weeks have seen an attack of existential angst among Europe’s major banks, on account of the challenges they face from America’s big universal banks.

y Professor Richard Roberts, King's College London

Since 2009, America’s top five banks have pushed their share of the global wholesale banking market from 48% to 59%, while the share of Europe’s top five universal banks fell from 35% to 31%. European big banks face harmful regulatory developments on their continent, as well as heightened discrimination against foreign players in the US market, the world's biggest fee pool. Europe's senior bankers have conjured the spectre of Europe’s corporates becoming reliant on non-European banks for their investment banking and hedging requirements.

Universal banking is a recently revived phenomenon in the US. Before 1933, there was no legal restriction on the combination of commercial and investment banking. In the 1920s, Citibank pioneered the universal bank model in the US, marketing its securities offerings to its retail banking customers. The quality of its offerings, for which it received hefty fees, plunged in the Wall Street boom and buyers sustained big losses from the 1929 crash. The chairman, Charles Mitchell, resigned in disgrace and was prosecuted for tax evasion (like gangster Al Capone).

Banks were accused of fuelling the boom and bust through their securities speculations. The Glass-Steagall Act of 1933, enacted on the back of an upsurge of public anger, after hearings revealed outrageous misdemeanours during the boom, imposed a legal separation between investment and commercial banking. 

But banks remained objects of popular antipathy and in 1947, the Democrat administration of Harry Truman filed an antitrust suit against 17 leading investment banks, charging them with conspiring to share business among themselves and charging oligopolistic rents for their services. 

The complex case proceeded for six years, but was eventually dismissed without outcome by Judge Harold Medina. The Glass-Steagall separation was eroded from the 1980s and finally abolished in 1999, with Citigroup (successor to Citibank) leading the charge into universal banking.

Across the Atlantic, universal banking has been the prevalent form in much of continental Europe from the 19th century. Banks compensated for the absence of capital markets in many European countries. 

While this generally assisted Europe's industrialisation, in the economic slump of the early 1930s, European countries with universal banking proved more prone to banking crises, because of losses on risky and illiquid assets, and experienced more severe downturns than countries whose banks focused only on commercial banking. 

In the US, the financial crisis of 2008 propelled the growth of universal banks, with securities firms converting into, or being merged into, commercial banks, but their robustness in a major downturn is untested.

Britain, which, by convention, had separate commercial banks and investment banks (merchant banks), did not have a banking crisis in the 1930s. 

London’s merchant banks experienced waves of opportunities and challenges but survived through repeated reinvention of their business model. 

In the 1920s they diversified from international services to domestic corporate finance. In the 1950s and 1960s, they pioneered Euromarket business, first deposits, and then bonds. But they later retreated in the face of competition from big balance sheet US, European and Japanese banks. In the 1990s the merchant banks experienced acute competition, principally from US investment banks and commercial banks (which were able to conduct investment banking business overseas). 

Rent-seeking margins from US activities allowed the US firms to cross-subsidised their expansion in London. This time, for one reason or another, the game was up for the merchant banks, and from 1987 to 2004 they were acquired mostly by European universal banks, enlarging and developing the latter’s investment banking activities.

The demise of the London merchant banks under pressure from US competitors is a discouraging precedent for Europe’s universal banks. 

But the capacity of ostensibly all-conquering universal banks to blow up in a crisis is not to be underestimated: central Europe’s prime universal banks had to be rescued by governments in 1931; and in 2008 US taxpayers bailed out mighty Citigroup (known among US Treasury officials as “the Death Star”). 

The big US banks are as unloved and untrusted as in the 1930s and 1940s, and their fee levels are akin to those that prompted the Medina suit. Come the inevitable future scandals and shortcomings, the launch of an antitrust suit, by, say, a populist Hillary Clinton administration, is not inconceivable. And maybe even a new Glass-Steagall Act?

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