Universal Banks

In addition to the traditional commercial banking activities of holding deposits and extending loans, universal banks offer a full range of financial services, including underwriting, issuing new offerings of stocks and bonds, and brokering stocks and bonds. Some universal banks provide insurance. Banks that only engage in underwriting new securities, floating new offers of securities, and brokering securities are called “investment banks.” Universal banks combine deposit banking of traditional commercial banking with investment banking.

In the 1800s, banks in continental Europe and Germany in particular developed along the lines of universal banks, whereas in Britain deposit banking and investment banking tended to remain separate. In the United States, financier moguls such as J. P. Morgan introduced universal banking in the United States in the last decades leading up to World War I. Congress cut short the development of universal banking in the United States with the enactment of the Glass–Steagall Banking Act of 1933. Aimed at restoring public confidence in banks, this act prohibited commercial banks from investing in the stock market or providing investment bank services.

In the German model of the 19th century, universal banks purchased corporate stock for customers. In exchange, customers yielded to banks proxies entitling banks to vote the customers’ shares in shareholder votes. The banks also purchased corporate stock on their own accounts. The control of a large piece of shareholder power ensured that the banks held positions on corporate boards of directors. The universal banks were also lenders to corporations. By holding seats on boards of directors, the banks had a voice in the management of companies that owed them money. In addition, they had an incentive to watch out for mismanagement at the expense of stockholders and creditors. It was an arrangement that put a large amount of power in the hands of banks.

In the post–World War II era, universal banks enjoyed the greatest legal acceptance and experienced the fullest development in Germany. German universal banks hold large equity positions in corporations, have representatives on their boards, and exercise proxy votes for customer shareholders. Japan and Switzerland also followed the universal banking model. The economic success of these countries, and particularly the rapid economic growth in Germany and Japan, began to restore confidence in universal banking. Banks in these countries help to minimize conflicts between debt and equity holders and keep corporate management under tighter rein. By ensuring access to long-term financing, universal banks shield corporate managers from short pressures from fluctuations in stock market prices.

Particularly in Germany, critics raised the issue of universal banks dominating the German stock market. It is said that rather than earning high dividends, banks were more interested in making loans to corporations on whose boards they had representation. In the 1990s, Germany experienced several corporate failures. In 1998, the German government enacted the Control and Transparency in Corporate Field Act. This act prohibits a bank holding more than 5 percent of a company’s shares from controlling the proxy voting rights for its bank customers who also own shares in the company.

In the 1990s, momentum began to build to approve universal banking in the United States. Critics worried that universal banks would choose riskier investments because under a system of FDIC insurance the cost of funds to a bank does not vary with the riskiness of its investments.

In 1999, the U.S. Congress lifted the ban on universal banking with the passage of the Financial Services Modernization Act of 1999. Replacing the Glass–Steagall Act of 1933, this act allowed the integration of banking, insurance, and stock-trading. By 2007, the United States boasted three large universal banks, Citigroup Inc., JPMorgan Chase & Co., and Bank of America Corp.

As the subprime financial crisis of 2008 unfolded in the United States, some observers felt the financial woes stemmed directly from dismantling the wall between deposit banking and investment banking. They were referring to the repeal of the Glass–Steagall Act. At first, the universal banks seemed to fare better than the investment banks. The financial crisis could be interpreted as a symptom of the shake-out and consolidation that analysts expected from the enactment of the Financial Services Modernization Act of 1999. As the financial crisis widened, however, the stock values of Citigroup, JPMorgan Chase, and Bank of America crashed, and the future of the institutions was very much in doubt. All three of the banks received large infusions of preferred stock investments from the United States Treasury.