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# **II. Determining the Scope of Permissible Activities of Financial Institutions**

- This section focuses, from an economic perspective, on the advantages and disadvantages of integrated banking and the various corporate structures under which banking can be conducted. It examines the following questions:

- How does the scope of permissible activities of financial institutions differ across countries?

- What impact do different configuration of permissible activities have on financial institutions' franchise value or what are the gains and risks from allowing broader banking powers?

- What are the costs and benefits of allowing banks to engage in commercial and investment banking, and to have ownership stake in non-financial institutions?

- What types of corporate structures are used for banking organizations and what are their respective benefits and costs?

- How do non-bank financial institutions relate to the rest of the financial system?

## **1. Introduction - the Structure of Financial Services Provision**

In most countries, regulation rather than competition determines a bank's range of products and services it can offer, the types of assets and liabilities it can hold and issue, and the legal structure of its organization. Regulators in countries have allowed for different configurations of pennissible activities certain types of financial institutions can undertake and for different types of organizational structures. Two models at the opposite end of the spectrum are a separate financial system, where banks are not allowed to engage in any type of securities or other, non-credit financial service activity, and a completely integrated system, where banks can provide all types of financial services, either directly or indirectly through subsidiaries with involvement in management. The latter is often called " universal banking". As there are other aspects often associated with universal banking--such as the ownership of non-financial institutions (that will be discussed in the next section)-we rather use the term "integrated banking" to refer to a wide scope of financial services provision within a single institution.

Out of 51 industrialized and emerging countries surveyed by the Institute of International Bankers in 1998, only China has a "pure" separate banking system (in the sense that banks are not allowed to engage in any type of securities activities). The majority (36) of countries surveyed, including all EU-countries, allow integrated banking, i.e., banks are allowed to conduct both banking and securities business (including underwriting, dealing and brokering all kinds of securities) within the same banking organization. Finally, in 15 countries, financial institutions are allowed to engage in securities activities (to a varying degree), either through a bank parent (12) or a bank-holding company structure (3). The US is the most prominent country with a bank holding company structure which also has quite restrictive regulations on securities businesses which can be undertaken by comrnmercial banks (see further Annex Table 1 and 2).1 Historically, that is before the late **19th** century/early 20 th century, the range of products and services individual financial institutions have offered (i.e., the scope of their financial services provision) has in many countries been determined by market forces. Competition, comparative

> 1 According to Section 20 of the U.S. Bank Holding Company Act, revenues that commercial banks derive from their securities subsidiary (underwriting and dealing activities) are restricted to less than 25 percent of their overall profits. Moreover, commercial banks are not allowed to hold an equity stake in non-financial firms (except for trading purposes).