Centre for Economic Policy Research

Session 3: Universal banking
Gertrude Tumpel-Gugerell 
Vice Governor, Economics and Financial Markets Department, Oesterreichische
Nationalbank, Vienna
Gertrude Tumpel-Gugerell opened the third session by observing that various
conflicts of interest can arise in a universal bank, notably between investment and
loan businesses. While universal banks are less dependent on the revenues from
individual business lines, the incentive structure is usually defined on a business
line level. An additional conflict of interest is whether universal banks should
expand loan business or develop the capital market. Turning to the issue of bank
failures, she identified three main weaknesses: 
1. a low level of checks and balances, so that a certain group of players has too 
much power relative to others; 
2. weak risk control systems, including imperfect separation of functions; and
3. weak auditors. 
The excessive exploitation of conflicts of interest is also a bank failure, yet one
that does not lead to insolvency, at least in the short run. Remedies must be
designed on a systemic basis.
Antonio Borges 
Goldman Sachs International
Antonio Borges adopted a more general definition of conflicts of interest. The 
current environment features very large losses and the focus is now on finding
scapegoats, magnifying the issue and neglecting or overlooking the empirical 
evidence. In this sense, the Report provides an interesting contrast with the 
current situation. 
Clearly, the stock market boom must remain central to the analysis. Without a
bubble, most of the issues of conflicts of interest would have been of little 
concern. Indeed, banks can be blamed, as well as other players such as rating
94 Conflicts of Interest in the Financial Services Industry

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agencies, auditors, opinion leaders, business leaders and academics. Everybody
followed in the great wave of euphoria leading to important distorted behaviour.
Herding behaviour should also be debated; the excesses stem more from this than
from the flaws of the financial system.
The historical focus of the Report is appreciated. It is amazing to see the 
similarities between the crises of the early 1990s and those of the 1920s. The 
statements and the way in which people describe the current situation are a 
carbon copy of what happened in those times: similar problem, similar behaviour,
similar explanations and similar excessive remedies. We have not learned from
history, in particular about the role of monetary policy in preventing the 
emergence of bubbles.
Governance is also an important issue. Financial markets have a key role in
allocating capital efficiently. Yet the information that they provide has a value in
itself beyond the efficiency argument. Notably, the lack of such information
would make it virtually impossible to exercise scrutiny over management. An
independent evaluation of management requires significant information, most of
which comes from financial markets. Therefore, when this information is not 
sufficient, the problem is far more severe than just an inefficient allocation of 
capital. The most positive outcome of the recent crises is the emphasis on 
disclosure, transparency and more rigorous financial information.
It is very myopic to argue that whenever conflicts of interest exist, they will
always be exploited. Reputational capital is crucial. In the particular case of 
universal banks, having the opportunity to exploit a conflict of interest rarely
leads to taking advantage of it. There are, however, some cases where 
reputational capital is not sufficient. To start with, a collective failure does not
allow for distinction between players, and poor performance becomes the norm.
Reputation by itself is not a sufficient check on behaviour. This issue has been
very important in recent years. In addition, in desperate situations long-term 
concerns are downplayed and the short run takes a disproportionate importance.
Powerful players can take advantage of conflicts of interest to obtain the short-run
relief necessary to survive.
Borges also argued that there must be some truth behind the argument of
economies of scope in universal banking, despite the lack of strong empirical 
evidence. There is a continuum of institutions from very specialized entities to
full-blown universal banks. Increasingly complex structures bring about 
additional costs which do not exist in smaller firms. Therefore, there must be 
significant additional benefits which justify the very existence of universal banks.
The most difficult issue in universal banking is the combination of investment
banking and credit granting. Is universal banking a superior model? Does it raise
special concerns? The evidence is that conflicts of interest remain rather limited,
and whenever they exist, they are rarely exploited. Borges thought that the most
serious conflict between investment banking and loan granting has a different
dimension than that expressed in the Report. Investment banking features high
barriers to entry and large resources are required to establish a sufficient market
presence. New entrants use credit granting to enter the market, thereby 
subsidizing their investment banking through underpricing of loans. As a 
consequence, there is significant mispricing of credit and excess demand for it.
This does not seem to be of any concern to regulators, although the consequences
for regulation are serious. On the loan granting side, entering institutions benefit
from a regime that does not apply to specialized investment banks.
Borges concluded that in terms of remedies, disclosure and transparency are
very important. The market participants should make their own judgements, 
provided that they have all the relevant information.
Discussion and Roundtables 95

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Hans Genberg 
Graduate Institute of International Studies
Hans Genberg emphasized two elements: the importance of reputation and the
role of market discipline. The Report focuses essentially on conflicts of interest in
the US banking industry before the Glass-Steagall Act of 1933 in order to look at
the source of the Act, at the facts, and to determine whether it was justifiable. The
legislation was the result of the perceived faulty behaviour of a relatively small
number of actors, and not of a careful analysis of the importance of conflicts of
interest for the market as a whole. Furthermore, the legislation came in the 
aftermath of large stock market declines, suggesting that it was at least in part the
result of popular pressures on the legislators. The same process might be at work
nowadays. Proposed solutions to the excesses of the recent period are driven in