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the recent proposed mergers--is good for consumers and for

the economy as a whole.

Potential Conflicts of Interest in Universal Banking

Whether commercial banks should be permitted to be in-

volved in investment banking and act as "universal banks"

has been hotly debated in the United States throughout most

of the 20th century.1  Following World War I, commercial

banks became increasingly involved in the underwriting of

securities.  The Glass-Steagall Act of 1933 halted that evo-

lution by forcing commercial banks to end their corporate

securities operations, a separation that was further codi-

fied in the Bank Holding Company Act of 1956.2

One of the major motivations for the separation of com-

mercial and investment banking both in the 1930s and today

is concern about the potential for "conflicts of interest":3

will the public be harmed by commercial banks' engaging in

investment banking?  Banks might abuse the trust of their

customers and take advantage of them by selling them low-

quality securities without fully revealing the risks, and

such behavior could broadly undermine confidence in the

markets and banks themselves.4  Because of the often long-

term lending relationship between a bank and a client firm,

banks may be better informed than the individual investor

about a client firm's soundness and prospects.  That infor-

mational advantage, however, can be a double-edged sword.

On the positive side, given its detailed knowledge of

the firm, a commercial bank might be better positioned than

an investment bank to provide information to prospective

purchasers of the firm's securities.  Through the lending

relationship, banks might know which firms have particularly

good prospects and might be able to help them to bring their

securities to the public markets earlier than would be the

case if the young firms had to try to start new relation-

ships with investment banks.  In other words, commercial

banks may enjoy a synergy in combining lending with under-

writing that could make them more efficient than independent

investment banks at monitoring and evaluating firms and se-

curities.

On the negative side, however, a commercial bank might

have an incentive to use its superior information to its own

advantage.  Commercial banks might have greater incentive

and greater ability to take advantage of investors than do

investment banks.  First, consider the incentives.  If the