FINANCIAL INSTITUTIONS AND CAPITAL MARTKETS
Banking Services through Subsidiaries
a) Investment Management Services
For many commercial banks, investment management is a major revenue producer. Although they are prohibited from making certain investments in corporate securities for their own accounts, banks manage billions worth of
securities for wealthy individuals, corporate clients, and various kinds of retirement asset funds through their trust and investment departments or subsidiaries. They also manage assets for corporate and/or pension funds;
various types of mutual funds, including money market mutual funds; and other investment companies. In each case, commercial banks exploit their investment skills and knowledge of the securities markets.
b)Advisory Services
Because of their expertise in financial markets and their relationships to depositors and borrowers, banks are also well situated to offer other advisory services.
These advisory services include:
1) Economic analysis,
2) Investment and financial advising,
3) Asset valuation services, and
4) Bankruptcy-workout counselling.
c) Brokerage Services
Several bank holding companies have begun to offer securities brokerage services, including discount brokerage. Although these services are officially offered through a separate subsidiary of the bank holding company, the
services may be provided within the confines of the commercial bank offices, and the separation of a commercial banking subsidiary from a stock brokerage subsidiary is not particularly apparent to the bank customer.
Another area in which banks act as brokers is insurance. Credit insurance, which is often used to insure repayment of loans, is offered directly by banks.
Other kinds of insurance may be offered through banks under certain restricted conditions.
d) Underwriting
Currently, all banking institutions are able to underwrite general obligation bonds and debentures. Some banks are major players in these markets, where they may have an advantage over investment banks when it comes to
underwriting state and local bond issues. The political ties and geographical
proximity that commercial banks have to the issuer are not irrelevant
considerations.
However, more recently, several institutions have been able to directly compete in the market for both corporate debt and equity. Over time, the corporate parent of the commercial bank, the so-called bank holding
company, has been allowed to establish a separate subsidiary to engage in securities market activity.
1.7 Economic functions
The economic functions of banks include:
1. Issue of money, in the form of banknotes and current accounts subject to cheque or payment at the customer’s order. These claims on banks can act as money because they are negotiable and/or repayable on
demand, and hence valued at par. They are effectively transferable by mere delivery, in the case of banknotes, or by drawing a cheque that the payee may bank or cash.
2. Netting and settlement of payments – banks act as both collection and paying agents for customers, participating in inter-bank clearing and settlement systems to collect, present, be presented with, and pay
payment instruments. This enables banks to economise on reserves held for settlement of payments, since inward and outward payments offset each other. It also enables the offsetting of payment flows
between geographical areas, reducing the cost of settlement between them.
3. Credit intermediation – banks borrow and lend back-to-back on their own account as middle men
4. Credit quality improvement – banks lend money to ordinary commercial and personal borrowers (ordinary credit quality), but are high quality borrowers. The improvement comes from diversification of the bank’s assets and capital which provides a buffer to absorb losses without defaulting on its obligations. However, banknotes and deposits
are generally unsecured; if the bank gets into difficulty and pledges assets as security, to rise the funding it needs to continue to operate, this puts the note holders and depositors in an economically subordinated position
5. Maturity transformation – banks borrow more on demand debt and short term debt, but provide more long term loans. In other words, they borrow short and lend long. With a stronger credit quality than most other borrowers, banks can do this by aggregating issues (e.g. accepting deposits and issuing banknotes) and redemptions (e.g. withdrawals and redemptions of banknotes), maintaining reserves of cash, investing in marketable securities that can be readily converted to cash if needed, and raising replacement funding as needed from various sources (e.g.
wholesale cash markets and securities markets).
