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.

2 Responses to “Building a new investment bank”

  1. This is an excellent article.

    Yes, “too big to fail” financial organizations have some decisions to make. If they do not use an advanced internal model and if they do not take advantage of enterprise-wide implementation, they are going to split.

    The FSB has proposed (and the G20 leaders endorsed in Seoul in November 2010) a policy framework, work processes and timelines for addressing the systemic and moral hazard risks associated with SIFIs (Systemically Important Financial Institutions) – firms whose disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity.

    George Lekatis

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