Economies grow through investment. Savers part with their hard-earned money to fund investments in factories, technologies and other productive enterprises that grow the economy over time. A healthy and stable financial system provides savers with multiple avenues to fund productive investments. Banks are a primary source of funding for investment. Savers maintain bank deposits that are then channeled to investment through the banking system.
In addition to obtaining funding from the banking system, companies that want to make investments also raise funds directly from the public by issuing debt and equity securities through the capital markets. The presence of a robust market-based financial system contributes to a well-diversified and healthy financial system that supports the economy. In this post, we review the role that large banks play in supporting the market-based financial system in the U.S.
While companies that raise debt and equity directly from the public through the capital markets are not reliant on bank credit, banks and other financial institutions are still necessary to ensure the smooth functioning of the market-based financial system. Specifically, when a company wants to issue debt or equity securities to the public, they typically do so by working with an underwriter at a large bank holding company.
An underwriter purchases the equity or debt directly from the company, thereby raising the funds, and then turns around and offers the debt or equity securities through a public offering. Once the securities have been sold to the public, underwriters also typically maintain a liquid secondary market for these securities so that the holders of debt and equity securities can buy and sell these securities as needed to meet savings and liquidity needs.
Figure 1 shows a breakdown of the amount of securities that have been underwritten for companies in the Dow Jones Industrial Average from 2016 through 2018 as reported in public filing disclosures. The underwriters are categorized into four different groups: 1) Financial Services Forum Members – the eight largest and most diversified U.S.-based banks, 2) Large Foreign Banks – these are large foreign banks with a size and scale similar to that of Financial Services Forum members, 3) Smaller U.S. Banks – these are U.S.-based banks and related financial firms other than Financial Services Forum members, 4) Smaller Foreign Banks – these are foreign banks and related financial firms other than Large Foreign Banks.
As shown in the figure, Financial Services Forum members have underwritten 57% of the securities that Dow companies have offered to the public from 2016-2018. Large Foreign Banks have underwritten 35% of these securities, while the remainder, 8%, has been underwritten by Smaller U.S. and Smaller Foreign Banks. The results in Figure 1 underscore two important facts. First, large banks – both U.S. and foreign – are critical to the market-based financial system in the U.S. Second, large U.S. and large foreign banks compete directly with each other in providing these services to large U.S. companies. A dynamic and competitive market is efficient and benefits everyone, but also underscores the need to ensure that regulatory policies – such as capital and liquidity requirements – be applied evenly across U.S. and foreign banks. Applying less stringent regulation to large foreign banks would put large U.S. banks at an unfair competitive disadvantage.
Figure 2 provides detail on underwriting activity for six large U.S. companies – Apple, Boeing, Disney, Home Depot, Microsoft, and Intel – that produce products and services used by many households across the country. The figure details the fraction of securities underwritten by the four groups of firms that are considered in Figure 1. As the figure shows, Financial Services Forum members provide a significant amount of underwriting to these firms. In the case of Intel, for example, Forum members provided over 90% of Intel’s underwriting needs, which further underscores the critical importance of large U.S. banks in the market-based financial system. The figure also shows that large foreign banks provide significant amounts of underwriting to these firms while smaller U.S. and foreign firms provide significantly less underwriting for these firms.
The U.S. economy has a healthy and well-diversified financial system in which companies can raise funding directly from households to support investment and growth. Large banks play a crucial role in supporting market-based finance through the provision of underwriting services. Forum members provide the bulk of underwriting services to large U.S. companies, like those in the Dow, but also face intense competition from large foreign banks. A vibrant and healthy market for underwriting services is good for companies that want to raise funds and good for the economy – that’s why it is critical that large U.S. and foreign banks face comparable regulation to ensure a level competitive playing field.