5. Conclusions
The paper presents an industrial organization model to formalize the popular idea that financial conglomerates may make bundled offers of financial services, using commercial loans as loss leaders to obtain lucrative investment banking business. By focusing on the monitoring role of commercial banks, we also examine the impact of universal banking on social welfare and market structure. In our model there are supranormal profits in the investment banking sector that cannot be eroded by competition due to incentive problems with underwriting; when underwriting fees are too low, investment banks exert an insufficient effort. Universal banking serves as a mechanism for competing for such investment banking profits through cross-subsidization from commercial banking. However, the resulting commercial loan terms, which are favorable to customers and unfavorable to commercial banks, have an adverse effect on commercial banks' monitoring incentives, encouraging the pursuit of private rents by entrepreneurs. Less equilibrium monitoring also leads to lower underwriting fees and a lower probability of successful underwriting. The social welfare effects of universal banking stem from the change in the level of monitoring. If the equilibrium level of monitoring in a functionally separated system is socially insufficient on a local scale, the universal banking system is unambiguously welfare-reducing because it exacerbates the inadequacy of monitoring. If, on the other hand, the equilibrium level of monitoring in a universal banking system is socially excessive on a local scale, the universal banking system is unambiguously welfare-increasing because it eases the excess of monitoring. Otherwise, universal banking has ambiguous social welfare effects.
