Ch. 5: Banks in Capital Markets 191
- Introduction
Banks are an important source of funding in economies around the world. Through
syndicated loans arranged by commercial banks, industrial firms borrowed 1.4 trillion
dollars in 2003 and 13.2 trillion dollars between 1993 and 2003.^1 The public capital
markets have also proved to be a very important funding source. Between 1993 and
2003, industrial firms issued 10.2 trillion dollars of public debt and 2.3 trillion dollars
of common stock.^2 Nearly 40 percent of equity issuance and 20 percent of debt issuance
occurred in the United States. These facts raise an important question—how do banks
directly and indirectly affect funding through capital markets?
Few regulatory issues have been as controversial as the appropriate scope of bank ac-
tivities. Should banks participate directly in capital markets, providing not just lending
services but also other services for the firm, such as public security underwriting? Both
academics and regulators have debated this issue for decades. In the United States, com-
mercial banks were permitted to underwrite public securities prior to 1933. However,
the stock market crash of 1929 raised concerns over the potential for conflicts of inter-
est and the fear that commingling of investment and commercial banking increased the
riskiness of the financial system. In response, Congress passed the Glass–Steagall Act,
which effectively prohibited banks from underwriting securities and set the basis for the
following sixty year separation of commercial and investment banking. While there has
been much rhetoric on potential conflicts of interest when banks combine lending with
underwriting, the academic literature on this subject burgeoned only recently.
We begin by reviewing some of the arguments and theoretical models that analyze the
implications of banks combining lending with underwriting. Much of the focus of these
studies is on the potential for conflicts of interest that can occur when banks use their
private information from lending relationships in underwriting their borrowers’ public
securities. These conflicts of interest are weighed against potential benefits, such as the
bank being able to credibly certify the quality of its borrowers to outside investors and
generate cost savings from informational economies of scope. This survey deals with
these issues and its scope is defined by our perception of this literature.
The theoretical analyses provide a framework for empirical tests of conflicts of
interest. These papers analyze the pricing and long run performance of commercial
bank-underwritten securities. The first papers use data on public security offerings from
before the enactment of the 1933 Glass–Steagall Act while more recent research uses
data from the 1980s and beyond, after the relaxation and eventual repeal of the Glass–
Steagall Act. Additional studies test whether banks can use organizational means to
reduce the potential for conflicts of interest, and other papers examine the effects of
a financial intermediary holding equity claims in firms. We also summarize the inter-
national evidence on the interaction between commercial banks and capital markets.
(^1) Estimates are from Loan Pricing Corporation, which gathers its loan data from SEC filings, large loan
syndicators, and a staff of reporters.
(^2) Global issuance. Estimates from Thomson Financial.