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The Growth of Financial Conglomerates
by
Charles Lamson
Financial conglomerates are firms that own and operate several different types of financial intermediaries and financial institutions. As a rule, they operate on a global basis. Financial conglomerates usually result from the mergers of several firms. For example, one financial conglomerate may own a commercial bank, a savings institution, a mutual fund, a pension fund, a securities firm and an insurance company. The alleged advantages of forming financial conglomerates include taking advantage of economies of scale, economies of scope, and diversification.
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Economies of scale, which are gains from large size, may result when separate firms owned by a conglomerate and offering the same product are able to streamline management and eliminate duplication of effort. The conglomerate may have fewer boards of directors than if there were many separate firms. They may also share a common technology infrastructure.
Economies of scope refer to the advantages of a conglomerate's ability to offer several financial services under one roof. This one-stop shopping is supposedly an advantage to financial services customers and, hence, gives financial conglomerates advantages over several separate firms providing the same set of services. In addition, the subsidiaries can share information about customers and seek new customers from other subsidiaries.
Diversification refers to the branching out of the financial conglomerate into several product lines. Diversification reduces the dependence of the financial conglomerate on one service. This, in turn, reduces the risk of failure for the financial conglomerate. If one division is performing poorly, the conglomerate can still be earning a profit if other divisions pick up the slack. For example, if the credit card division is losing money, it can be subsidized by the insurance division for awhile. If credit cards were the dominant product line of a financial services institution, losses in this area could affect the solvency of the institution. This is not so in the case of a financial conglomerate.
Financial conglomerates have been emerging in the financial world since the early 1970s. Some of the first attempts were started by nonfinancial giants, such as Sears, that bought financial subsidiaries. Not all the early attempts at forming financial conglomerates met with success, particularly when they originated with a nonfinancial firm that was purchasing financial institutions. For example, in 1981, Sears purchased Dean Witter Stock Brokerage and Coldwell Banker Real Estate only to sell them in 1989 because of losses in these subsidiaries.
Regulations dating back to the Glass-Steagall Act, during the Great Depression, attempted to prevent different types of financial firms from merging and providing a vast array of financial services. However, by the mid-1990s, many institutions were already finding loopholes in existing regulations in order to form financial conglomerates, and impetus was building to do so. In November 1999, Congress passed the Gramm-Leach-Bliley Act (GLBA), also known as the Financial Modernization Act. The passage of this law gave new impetus to the formation of financial conglomerates. The law effectively repealed Glass-Steagel and allowed for the formation of financial holding companies (FHCs). FHCs may own securities firms, banks, and insurance companies. They may also engage in ancillary financial and complementary nonfinancial enterprises. By March 2000, the effective date of GLBA, there were already 111 FHCs, and by October 2001, the number of FHCs had increased to about 600.
Rather than maintaining the status quo of segmentation among financial service providers, the GLBA encourages considerable financial integration in the financial services industry and the formation of financial conglomerates.
Since the 1990s, there have been three trends in financial markets: growth, consolidation, and globalization. These trends have been emphasized repeatedly throughout this text. We expect these trends to continue in the future and that financial markets and institutions will be most influenced by these factors as they evolve.
Financial conglomerates operate several different financial intermediaries and financial institutions that provide an array of financial services on a domestic and global basis. They result from consolidation in the financial services industry due to economies of scale, economies of scope, and diversification. Passage of the GLBA encouraged the formation of financial conglomerates.
*SOURCE: THE FINANCIAL SYSTEM & THE ECONOMY, 3RD ED. 2003, MAUREEN BURTON & RAY LOMBRA, PGS. 366-368*
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