Building a new investment bank May 26, 2011 at 8:01 am
The news that UBS might split itself into a Swiss retail bank and an investment bank got me thinking: how would you structure an investment bank today if you had a clean sheet of paper?
Now of course you can’t start from scratch: every large bank is an accertion of history, mergers, long-past legal structuring decisions and so on. Someone in 1981 tried to save some tax and the firm has been living with 17 entities in Cayman ever since, for instance. [I don't condone this kind of behaviour, by the way: not at all.]
But what if you could design a new investment bank? Well, you certainly would not want the entity to have a banking license. Simply deciding to be a broker/dealer saves you from a massive amount of regulation. You might have bank subsidiaries in a few parts of the world – such as the EU* – but the top entity would certainly want to be a non-bank. You’d probably try to arrange it to be small enough not to be a SIFI, yet large enough to be able to raise funds reasonably cheaply. In the US you would operate as an SEC regulated broker/dealer, with CFTC-regulated swap dealer subsidiaries. And the holding company and management would probably sit in a supportive jurisdiction like Singapore. Ideally I’d want the firm to be at least part-owned by a larger industrial company so that I could rent their balance sheet and credit rating, but that is not essential. And of course I would use conduits extensively as a funding and off-balance sheet risk mechanism.
This kind of game of fantasy structuring is instructive in that it shows how uneven the playing field is between banks and non-banks and between different jurisdictions. We still have a long way to go in managing systemic risk if there are huge advantages available in changing your legal structure or domicile.
* There is no capital benefit in the EU to being a non-bank so you might as well go the whole hog and be a bank so that you can at least take deposits. Beware the financial conglomerates directive though: that will limit your freedom of action somewhat.