One potential explanation is that high fees on underwriting and advisory activities are sustained as a reputational equilibrium. In effect, clients are willing to pay a premium to have bonds or equity underwritten by a recognised name, as this is a signal of quality to endinvestors. A similar phenomenon might explain the “2 and 20” fee structure of hedge funds. The OFT has recently announced an investigation into underwriting fees in the UK market. 6  CHAPS is the same-day electronic funds transfer system, operated by the bank-owned CHAPS Clearing Company, that is used for high-value/wholesale payments but also for other time-critical lower value payments (such as house purchase). BIS Review 95/2010  13  Another part of the puzzle was banks’ approach to managing risk across these business lines. For example, treasury functions are designed to help a firm as a whole manage its balance sheet, with internal transfer pricing for liquidity services to business lines. By acting in that way, the risk-taking incentives of each business unit can be aligned with the business as a whole, thereby complementing firms’ internal risk management. In practice, during the run-up to crisis, treasury functions were often run as a profit centre. That would tend to encourage two sets of risk-taking behaviour. First, it may have encouraged banks to take risks in balance sheet management – for example, by seeking out cheaper sources of capital (for example, hybrids over pure equity) or liquidity (shorter-term unsecured borrowing over long-term secured funding).

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