Investment and Commercial Banking: To Merge or Separate? An Empirical Analysis

Abstract

A major concern of regulators in the banking industry is how to decrease the risk exposure of banks and prevent a possible collapse. It is a widely held view that bank collapse is contagious hence if a few banks cave in it will inevitably lead to the destruction of the financial system as a whole. In the United States, commercial banks are allowed to establish section 20 subsidiaries to provide investment banking services. This, in the opinion of many industry analysts poses a heightened risk. Many analysts have therefore suggested that risky investment activities should not be merged with traditional depository activities of commercial banks. This paper assessed the merits and demerits of such a proposition by empirically analyzing the four largest banks in the US by market capitalization as of 2014. Tests of possible bankruptcy with the use of the modified Altman and Ohlson metrics were employed. Capital Adequacy and Size were also analyzed between the years of 2011 and 2014. As is consistent with the findings of some prior studies, this paper came to the conclusion that by allowing the two banking activities to be merged under one holding company, it was not only risk that increased but the banks’ ability to withstand shocks.