190 S. Drucker and M. Puri
7.2. Beyond screening and monitoring 223
7.3. Loan sales 223
7.4. Bank organizational form 225
7.5. Bank-based vs. market-based economies 226- Concluding remarks 226
References 227
Abstract
Banks are an important source of funding in economies all around the world, making
it vital to understand how banks directly and indirectly affect funding through capital
markets. Few issues have perhaps been as controversial as the appropriate scope of bank
activities and whether banks should participate directly in capital market activities, pro-
viding both lending and other services, such as underwriting. We review the arguments
and theoretical models that consider the consequences of commercial banks engaging
in investment banking activities, and we examine the empirical evidence on the poten-
tial for conflicts of interest, which focuses on the pricing and long run performance of
debt and equity underwritten securities, both in the United States and internationally.
A related topic is whether investment banks and commercial banks can co-exist as un-
derwriters. We summarize the theoretical and empirical literature, focusing on the effect
that bank lending has had on underwriter fees and the ability of banks to win underwrit-
ing mandates, as well as how investment banks have adapted to commercial bank entry
into investment banking. We also consider the indirect role of commercial banks in cap-
ital markets, providing a summary of banks’ ability to signal the quality of borrowers
through their decisions to originate and sell loans. Finally we examine related topics,
such as the effects of banks holding equity and engaging in venture capital activities,
and we suggest research directions.
Keywords
commercial banks, investment banks, underwriters, certification, conflicts of interest,
Glass–Steagall