The flaw in universal banking

It's never too late for a mea culpa. John Reed, who drove the transformation of Citibank into a universal bank with the merger with the Travelers Group in 1998, now thinks the universal banking model is fatally flawed. He gives two reasons:

One was the belief that combining all types of finance into one institution would drive costs down — and the larger the institution the more efficient it would be. We now know that there are very few cost efficiencies that come from the merger of functions — indeed, there may be none at all. It is possible that combining so much in a single bank makes services more expensive than if they were instead offered by smaller, specialised players.

The second thing we were wrong about has to do with culture — and this turns out to be very serious. Mixing incompatible cultures is a problem all by itself. It makes the entire finance industry more fragile. This is what I mean by an unstable cultural balancing act at the core of universal banking and, the restructurings and management changes we are now seeing in European financial institutions.
As is now clear, traditional banking attracts one kind of talent, which is entirely different from the kinds drawn towards investment banking and trading. Traditional bankers tend to be extroverts, sociable people who are focused on longer term relationships. They are, in many important respects, risk averse. Investment bankers and their traders are more short termist. They are comfortable with, and many even seek out, risk and are more focused on immediate reward. In addition, investment banking organisations tend to organise and focus on products rather than customers. This creates fundamental differences in values. 

The first explanation has merit, although Jamie Dimon of JP Morgan would not agree. The second explanation applies to universal banks whose investment banking income is derived mostly from trading activities. It would not apply to universal banks whose investment banking activities have mostly to do with underwriting and advisory work or to banks that are not exposed to non-banking activities such as asset management, insurance, etc because these activities are carried out by independent, affiliate companies in a group (as in the case if HDFC Bank or ICICI Bank).

Thus, the problem is not universal banking per se but the particular model of universal banking that became the norm in the US. The Indian model of universal banking has been very successful indeed because Indian banks' exposure to investment banking is related to merchant banking activities and not to proprietary trading.