Chapter Fourteen

Investment Banking, Insurance, and

Other Sources of Fee Income

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Key Topics

• The Ongoing Search for Fee Income

• Investment Banking Services
• Mutual Funds and Other Investment Products
• Trust Services and Insurance Products
• Benefits of Product-Line Diversification
• Economies of Scope and Scale
• Information Flows and Customer Privacy

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Introduction
• Financial institutions have faced a struggle recently to attract the
funds they need in order to make loans and investments and boost
their revenues
• Whenever deposit growth slows, financial-service managers
frequently are forced to pursue new sources of funds and new ways
to generate revenue
• Important source of growth in future revenues – fee income
▫ Revenues derived from charging customers for the particular
services they use
▫ Monthly service charges on transaction accounts
▫ Commissions for providing insurance coverage for homes and
businesses
▫ Membership fees for accepting and using a particular credit or debit
card
▫ Fees for providing financial advice to individuals and corporations
▫ “Swipe fees” at the point of sale
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Introduction (continued)
• The drive among competing financial firms to generate more fee
income as an increasingly important revenue source comes from
several sources
▫ A desire to supplement traditional sources of funds (such as
deposits) when these sources are inadequate
▫ An attempt to lower production costs by offering multiple services
using the same facilities and resources (economies of scope)
▫ An effort to offset higher production costs by asking customers to
absorb a larger share of the cost of both old and new financial
services
▫ A desire to reduce overall risk to the financial-service provider’s
cash flow by finding new sources of revenue not highly correlated
with revenues from sales of traditional services
▫ A goal to promote cross-selling of traditional and new services in
order to further enhance revenue and net income
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Sales of Investment Banking Services

• One banking service that has been prominent, but volatile, is investment banking
• Many leading U.S. banks recently either acquired or formed their own investment
banking affiliates in order to serve corporations and governments around the
world
▫ For example, JP Morgan Chase’s acquisition of Bear Stearns
• Leading investment banks in the world today:
▫ Citigroup
▫ JP Morgan Chase
▫ Morgan Stanley
▫ Goldman Sachs
▫ Credit Suisse
▫ UBS
▫ Nomura Securities
▫ Deutsche Bank
▫ Raymond James
▫ Banc of America Securities
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Sales of Investment Banking Services

(continued)
• Key Investment Banking Services
▫ Traditionally, the best-known and often the most profitable
investment banking service is security underwriting
▫ The purchase for resale of new stocks, bonds, and other
financial instruments in the money and capital markets on
behalf of clients who need to raise new money
▫ One of the most profitable underwriting services – initial
public offerings (IPOs)
▫ Leveraged buyouts (LBOs)
▫ Involve the acquisition of a company, usually by a small group
of investors, and typically are funded by large amounts of debt
▫ Recently, many investment banks jumped into the hedge
fund business
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Sales of Investment Banking Services

(continued)
• Examples of client questions that investment bankers can
assist in answering:
▫ Should we (the investment bank’s clients) attempt to raise
new capital? If so, how much, where, and how do we go about
this fund-raising task?
▫ Should our company enter new market areas at home or
abroad? If so, how can we best accomplish this market-
expansion strategy?
▫ Does our company need to acquire or merge with other
firms? Which firms and how? And when is the best time to do
so?
▫ Should we sell our company to another firm? If so, what is
our company worth? And how do we find the right buyer?
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Sales of Investment Banking Services

(continued)
• With passage of the Gramm-Leach-Bliley (GLB) Act of
1999, the full range of investment banking services was
opened up for adequately capitalized and well-managed
commercial banking firms
• Research studies suggest that investment banking revenue
and profitability are positively, but not highly, correlated
with commercial banking revenues and profitability
▫ There may be some significant product-line diversification
effects
• It is not yet clear that the benefits alleged from this new
service dimension have offset the costs and risks involved

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Sales of Investment Banking Services

(continued)
• Investment banks today are wrestling with the question of what
kind of financial firm they need to be in the future
▫ What mix of services should they be offering to achieve high and
sustained profitability?
• A few commercial bank–investment bank combinations have
shown promise for the future, despite ongoing struggles to fend
off losses following a huge mortgage market meltdown in 2007–
2009
• Recently both investment banks and commercial banks have
been under intense pressure to raise large amounts of new
capital
• Many observers anticipate more mergers
▫ It is not clear that future commercial bank-investment bank
combinations will consistently turn out well
▫ One likely outcome is greater government regulation
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Selling Investment Products to Consumers

• In recent years many of the largest business and household
depositors have moved their funds out of deposits at banks and
thrift institutions into investment products
▫ Stocks, bonds, mutual funds, annuities, and similar financial
instruments
• Mutual Fund Investment Products
▫ One of the most popular of the investment products
▫ Each share in a mutual fund permits an investor to receive a pro
rata share of any dividends or other forms of income generated by a
pool of stocks, bonds, or other securities the fund holds
▫ If a mutual fund is liquidated, each investor receives a portion of the
net asset value (NAV) of the fund after its liabilities are paid off,
based on the number of shares each investor holds
▫ Proprietary funds versus nonproprietary funds
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Selling Investment Products to Consumers

(continued)
• Annuity Investment Products
▫ Annuities are a hedge against living too long and outlasting one’s
savings
▫ Fixed annuities promise a customer who contributes a lump sum of
savings a fixed rate of return over the life of the annuity contract
▫ Variable annuities allow investors to invest a lump sum of money in
a basket of stocks, mutual funds, or other investments under a tax-
deferred agreement, but there may be no promise of a guaranteed
rate of return
▫ Recently a new type of annuity contract has appeared, the equity-
index annuity
▫ Combines the features of both fixed and variable annuities
▫ One advantage for financial firms selling this service is that
annuities often carry substantial annual fees
▫ One significant disadvantage with annuities sold through depository
institutions is they typically compete with selling deposits
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Selling Investment Products to Consumers

(continued)
• Several problems and risks are associated with sales of
investment products
• Current U.S. regulations require that customers must be
told orally (and sign a document indicating they were so
informed) that investment products are:
1. Not insured by the Federal Deposit Insurance
Corporation (FDIC)
2. Not a deposit or other obligation of a depository
institution and not guaranteed by the offering
institution
3. Subject to investment risks, including possible loss of
principal
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