3.2 Banks

market for a whole range of nancial products and services. A careful examination of

any of these branches conrms that traditional banking functions (deposits and cash

withdrawals) occupy a minority of space in large banking halls which were originally

designed for a very labour-intensive operation. The reduction in cashiers and counter

space has been facilitated by the development of ATMs which will also be found

inside the banking hall, offering the full range of services we referred to above. The

remaining space, typically half the oor area, will be devoted to the marketing of

a range of products and services, some of which (foreign exchange, personal loans,

trustee and executorship) are traditional activities, while some (insurance, mortgages,

pensions, mutual funds) most decidedly are not but represent the movement towards

universal banking that we discussed at the beginning of this chapter.

By contrast, wholesale banks are less heavily engaged in the traditional banking busi-

ness of deposit taking and loan making. This is especially true of those that specialise

in investment banking and asset management. Where deposits are concerned, these

are much fewer in number but individually much larger than for retail banks. A high

proportion is also denominated in foreign currencies (nearly 80 per cent of the total,

compared with 25 per cent for retail banks). The vast majority (by value) are time

deposits and so wholesale banks are much less exposed to the risk of unforeseen

withdrawals and hold very few truly liquid assets. They hold no operational deposits

at the Bank of England, preferring where necessary to hold deposits with the Big

Four retail banks. The high proportion of time deposits means that the degree of

‘maturity transformation’ is markedly less than for retail banks. Finally, recall that

we noted earlier that the Bank of England lists approximately 500 banks operating

in the UK. Since retail banking services are provided by the Big Five plus, at most,

eight other institutions, it follows that wholesale banks are extremely numerous.

The fact that they are mainly invisible (except to visitors to the City of London and

Canary Wharf) simply tells us that the bulk of their activities does not require a

branch network.

As Figure 3.1 shows, ‘wholesale banking’ refers to a range of activities. ‘Corporate

banking’ refers to the provision of banking services to large rms. In many cases,

these services are scaled-up versions of the banking services provided by retail banks

to households. The deposits are large, generally time, deposits; the loans are also

large and may take the form of overdrafts or may be long-term lending secured

on specied assets. The banks also provide advice, but it is advice relevant to the

operations of large rms – on hedging foreign currency risk, for example, or using

nancial derivatives, or making a major investment decision.

‘Investment banking’, by contrast, has little obvious contact with traditional

banking. Investment banks are heavily involved in security market operations. They

employ ‘analysts’ whose job it is to study corporate trends and identify rms as over-

or under-valued, or as high-growth and low-growth, high-risk and low-risk, etc. The

results of the research are provided to clients who are often managers of mutual funds.

The banks will sometimes be ‘market makers’ in equity or bond markets. Because

of this expertise, they will usually handle the issue of new securities on behalf of

companies wishing to become limited companies for the rst time or which wish

to raise additional capital for expansion. Their most high-prole work, which does

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Chapter 3 • Deposit-taking institutions

occasionally bring them to public attention, involves their negotiating on behalf of

clients during mergers and acquisitions or ‘M&As’.

This particular mix of activities has given rise to the allegation that there are poten-

tial conicts of interest in investment banking because analysts will be reluctant to

write adverse reports about companies which are clients for the investment banks’

other services. In 2002 several Wall Street investment banks achieved notoriety

when it was revealed that their analysts were writing favourable reports (for fund

managers and other investors) about rms that they privately regarded as very bad

value. These reports obviously pleased the rms in question, which then favoured

the banks with other business, in particular using the banks to handle new issues of

securities and to advise on mergers, etc. In April 2003, Citigroup, CSFB and Merrill

Lynch agreed to pay $880m in nes after an investigation by the US Securities and

Exchange Commission and the New York attorney general.

Banks’ income is earned from two principal sources. The lending rates are higher

than deposit rates and this ‘spread’ forms the traditional source of prot for banks.

But increasingly banks earn income from charging fees for advice and other services.

Fee income is generally more important to wholesale banks, and especially to invest-

ment banks, than it is to retail banks where deposit taking and lending remains a

large part of the banks’ business.