6 bank and a client firm, the bank is better informed than the public investor about a firm's soundness and prospects. This informational advantage may, however, be a double-edged sword. On the positive side, an integrated bank might be better positioned than an specialized investment bank to certify credibly the value of a security offered by the firm. On the negative side, an integrated banks might have a greater incentive and greater ability to take advantage of investors. Banks might abuse the trust of their customers and sell low quality securities to them without revealing risks, or raise lending rates to the same borrowers. Conflicts of interest concerns are important in the context of the banks' proprietary activities (i. e. when the bank acts on its own account), they are of less importance when the bank acts as an agent.

Empirical studies for the German (universal) banking system and for the US (pre- GlassSteagall) have not found any evidence of abusive practices by commercial banks. Two extensive studies commissioned by the Germnan government in the 1970s (Bueschgen 1970, Gessler Commission 1979) did not find substantial empirical support that banks were using their informational advantage on firms to the disadvantage of securities investors. For the US (pre-Glass-Steagall), if commercial banks had abused their informational advantages and sold low quality securities to investors than one would expect securities underwritten by comnmercial banks to have performed worse ex-post than similar securities underwritten by investment banks. This is, however, not the case. A study found that securities underwritten by commercial banks performed better than similar securities underwritten by investment banks (Kroszner and Rajan 1994). Their findings confirmed results of Ang and Richardson (1994) and Puri (1994).

# _Safety and Soundness and the Safety Net_

A combination of securities and commercial banking activities can increase the risk of bank failure (for a more extensive discussion of these issues, see Saunders 1994). While this has at times happened in emerging markets as well as developed countries (e.g., Barings), empirical evidence does not confirm this possibility as a general proposition. An empirical analysis of bank failures in the 1920s in the US for example found that banks undertaking securities activities were no more likely to fail than banks with no connection to the securities business (White 1986). More generally, there is no strong evidence that the combination of financial activities increases risk, and they might well reduce risks. For example, Wall and Eisenbeis (1984), using accounting data at the industry level, find that there was a negative correlation between bank earnings and securities broker/dealer earnings over the 1970 to 1980s period.<sup>9</sup> Nevertheless, safeguards can be necessary to avoid the transfer of explicit and implicit deposit insurance subsidies from the banking part of the institution to the securities part (Kane (1996) and Schwartz (1992) discuss in details how these transfers can occur). These safe-guards can take the form of market value accounting, timely monitoring and disclosure, more risk-sensitive capital requirements, firewalls between different type of operations, strong prompt corrective action procedures, including the closure of insolvent banks, and risk-based pricing of deposit insurance.

9 For a review of this literature see Brewer, Fortier, and Pavel (1989) and Benston (1990).