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Us investment banks are under siege, Competitors have long tried to force open the doors to the lucrative world of US investment banking. In 2000, when Congress repealed the Glass-Steagall Act, which prevented banks from offering both commercial- and investment-banking services, the final barrier to integration fell. Today, commercial and universal banks, such as Citigroup and J. P. Morgan Chase, as well as European-owned banks, including Credit Suisse First Boston and UBS, are a formidable competitive threat.
Spurred on by the fact that investment-banking services are far more profitable than commercial-banking ones (Exhibit 1, on the next page), universal and commercial banks are grabbing an increasing share of the investment-banking market. Their strategy for winning new business in it is often to give clients credit facilities as well-something that investment banks traditionally haven't done.
Still more worrying for investment banks is the fact that some clients now demand credit in return for M&A and underwriting business. In the spin-off of the microelectronics unit Agere Systems, for example, Lucent Technologies did business only with banks that were willing to provide credit too; J. P. Morgan Chase and Citigroup each committed as much as $1.25 billion in loans, while investment bank Morgan Stanley agreed to buy $2.6 billion in Lucent debt. Goldman Sachs, though it had co-led the original spin-off of Lucent from AT&T, declined to take part in the credit package and was excluded from the deal. (1)
Rough analysis suggests that the return on equity of the investment banks could fall by as much as 30 percent if they provided all clients with credit at the rates recently seen. Yet the prevailing view on Wall Street is that lending has become a necessity in the investment-banking world and that universal banks thus have a critical advantage. Investment banks, it is held, must obtain their own credit capabilities, even at the cost of depressing their rates of return. Some people have gone as far as to suggest that the linking of credit with investment banking will spell the end of the independent investment banks as the remaining ones are forced to merge with or acquire commercial banks to remain competitive.
We disagree. While providing credit is an important competitive advantage right now--at the height of a severe credit crunch--it is not sufficient justification for rushing into a potentially difficult merger with a commercial bank on unattractive terms. Certainly, to remain competitive, investment banks will need to build their credit capabilities and to offer loans selectively to clients. But once the credit cycle improves, credit will not make up for a lack of top-tier capabilities in the investment-banking business. Some universal banks will undoubtedly rise to the top of it, but only by developing superior skills.
Are the lines blurring?
Universal and commercial banks are currently gaining market share in almost all product categories (Exhibit 2). (2) More important, they appear to be leveraging their existing client relationships to win investment-banking business (Exhibit 3). Closer consideration of the figures, however, suggests that the advantage of offering credit may be overstated.
Universal and commercial banks have made their biggest gains in debt products, in which they now account for more than half of new issues. This development is hardly surprising, since the underwriting of debt products requires skills that are closely related to credit, the traditional area of expertise for both commercial and universal banks. (3) Moreover, it is the CFO or treasurer who purchases both product lines, an arrangement that confers useful opportunities to cross-sell products.
Even in debt products, though, universal banks have not systematically captured market share in every part of the business. While J. P. Morgan Chase and UBS have captured organic market share in both investment-grade and high-yield debt, Citigroup …