The Profitability and Risk Effects of Allowing Bank Holding Companies to Merge With Other Financial Firms: A Simulation Study

Perhaps the hottest debate in banking today is the one about letting bank holding companies (BHCs) engage in certain financial lines of business outside of commercial banking. 1 Large BHCs have vigorously argued for lowering barriers to entry into investment banking, fullservice securities brokerage, the insurance business, and real estate investment and development. These BHCs point out that nonbank financial firms such as securities firms and insurance companies have been permitted into traditional bank activities. They argue that lowering the entry barriers into nonbank activities would not only be equitable-by leveling the playing field-but would also bring some needed competition into nonbank activities. 2 Critics of expanded BHC powers argue that if BHCs enter currently prohibited activities, the risk to bank subsidiaries will increase. They argue that many of the sought-after nonbank financial activities are riskier than commercial banking. Therefore, if BHCs are permitted to expand into those activities, they say, the incidence of commercial bank failure-or its common analogue, the Federal Deposit Insurance Corporation (FDIC) rescue-will quite likely increase.