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Securities activities by commercial banking firms' Section 20 subsidiaries: risk, return and diversification benefits

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  • Simon Kwan

Abstract

This paper studies the implications of securities activities on bank safety and soundness by comparing the ex-post returns between banking firms' Section 20 subsidiaries -- subsidiaries that were authorized by the Federal Reserve to conduct bank-ineligible securities activities -- and their commercial bank affiliates. I found that securities subsidiaries that are primary dealers of government securities, their higher risk partially comes from their higher leverage, whereas for those that are not primary dealers, despite having lower leverage, they tend to be riskier than their bank affiliates partly because of their aggressive trading behavior. Nevertheless, securities subsidiaries appear to provide diversification benefits to bank holding companies, as evidenced by the low return correlation between bank subsidiaries and securities subsidiaries. Within the class of securities activities, I found that securities trading tends to be more profitable and riskier than banking activities. Trading activities engaged by primary dealer securities subsidiaries tend to provide strong diversification benefits to banking activities, reducing the banking organization's overall risk. For non-primary dealers, due to their aggressive trading behavior, their trading activities were found to increase the firm's total risk. On the other hand, securities underwriting is found to be riskier, and in the case of non-primary dealers also less profitable, than banking activities. Nevertheless, its return exhibits low correlation with banking return and trading return, suggesting that securities underwriting provides potential diversification benefits to both banking and trading activities.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 98-10.

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Date of creation: 1998
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Handle: RePEc:fip:fedfap:98-10

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Keywords: Banking Act of 1933 ; Investment banking ; Nonbank activities ; Banks and banking;

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Cited by:
  1. Lepetit, Laetitia & Nys, Emmanuelle & Rous, Philippe & Tarazi, Amine, 2008. "The expansion of services in European banking: Implications for loan pricing and interest margins," Journal of Banking & Finance, Elsevier, vol. 32(11), pages 2325-2335, November.
  2. Alan K. Reichert & Larry D. Wall, 2000. "The potential for portfolio diversification in financial services," Economic Review, Federal Reserve Bank of Atlanta, issue Q3, pages 35-52.
  3. Saoussen Ben Gamra & Dominique Plihon, 2011. "Revenue diversification in emerging market banks: implications for financial performance," Working Papers hal-00598136, HAL.
  4. Philip E. Strahan & Amir Sufi, 2001. "Expansion of bank powers: who gains the most?," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 682-698.
  5. Victoria Geyfman, 2005. "Risk-adjusted performance measures at bank holding companies with section 20 subsidiaries," Working Papers 05-26, Federal Reserve Bank of Philadelphia.
  6. Saoussen Ben Gamra & Dominique Plihon, 2011. "Revenue diversification in emerging market banks: implications for financial performance," CEPN Working Papers hal-00598136, HAL.
  7. Robert DeYoung & Karin P. Roland, 1999. "Product mix and earnings volatility at commercial banks: evidence from a degree of leverage model," Working Paper Series WP-99-6, Federal Reserve Bank of Chicago.
  8. Philippe Jorion, 2005. "Bank Trading Risk and Systemic Risk," NBER Working Papers 11037, National Bureau of Economic Research, Inc.
  9. Rosie Smith & Christos Staikouras & Geoffrey Wood, 2003. "Non-interest income and total income stability," Bank of England working papers 198, Bank of England.
  10. George Alessandria & Horag Choi, 2005. "Do sunk costs of exporting matter for net export dynamics?," Working Papers 05-20, Federal Reserve Bank of Philadelphia.
  11. Victoria Geyfman, 2005. "Banks in the securities business: market-based risk implications of section 20 subsidiaries," Working Papers 05-17, Federal Reserve Bank of Philadelphia.
  12. Allen N. Berger, 2000. "The integration of the financial services industry: where are the efficiencies?," Finance and Economics Discussion Series 2000-36, Board of Governors of the Federal Reserve System (U.S.).
  13. Berger, Allen N. & Demsetz, Rebecca S. & Strahan, Philip E., 1999. "The consolidation of the financial services industry: Causes, consequences, and implications for the future," Journal of Banking & Finance, Elsevier, vol. 23(2-4), pages 135-194, February.
  14. Simon H. Kwan & Elizabeth S. Laderman, 1999. "On the portfolio effects of financial convergence - a review of the literature," Economic Review, Federal Reserve Bank of San Francisco, pages 18-31.

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