Glass Steagall and Japan

As we have noted, the removal of Glass Steagall resulted in the end of the separation of investment and commercial banks.  It is inevitable, as a result, that investment banks as a meaningful force in the capital markets will disappear.  They will either go out of business or, more likely, be acquired by commercial banks, more conservatively run businesses with a competitive advantage on funding. 

This has already occurred with respect to Bear Stearns, soon to become a subsidiary of JP Morgan.  Merrill Lynch narrowly escaped becoming a subsidiary of Wachovia.  This phenomena is discussed at greater length the article, The "Great Fall":  The Consequences of Repealing the Glass-Steagall Act.  

Japan was another country that preserved a separation between commercial and investment banking, a legacy of US policy during the occupation.  The separation was always a bit of a slight of hand since the four large Japanese brokers were tied to particular banks.  Nonetheless, a legal separation existed.  As in the US, the barriers have been coming down.  Apparently they are coming down even further, with the result inevitable.  Larger brokers with any meaningful role in the capital raising process will disappear.  As the WSJ article notes, "Japan's big banks are hoping a planned change in the rules separating banks and securities houses will solidify their dominant positions in the Japanese financial-services industry." 

Of course, the reform facilitates the ability of brokers to enter commercial banking and the article notes that Nomura has already acquired Ashikaga Bank, a regional bank.  But in the long term, it will be the brokers who lose out.  In the post-war era, there were four significant Japanese brokers:  Nomura Securities, Daiwa Securities, Nikko Securities and  Yamaichi Securities.  Yamaichi is gone, Nikko has been purchased by Citigroup.  And the advantages of commercial banks continue with the same fate likely to befall Nomura and Daiwa.  As the article noted:

• The easing of the regulation is likely to be viewed cautiously by smaller banks and brokerage companies. In Japan, companies have traditionally had strong ties with banks, rather than brokerage companies, as they for decades relied primarily on bank loans, rather than issuing bonds and stocks in the capital markets, to meet their funding requirements. Banks also have better access to business from individuals as the Japanese have preferred keeping money in bank deposits rather than investing in stocks and bonds.

Capital markets need entities that focus exclusively on raising funds not through loans but in the capital markets.  While commercial banks can perform these task, they bring a traditionally more conservative approach to the business.  As a result, disappearance of an independent class of investment banking firms is likely to harm the vibrancy of the capital markets.  For those concerned about the competitiveness of the US capital markets, they should be concerned about this increasingly inevitable development.