Banks venture into new territory

Financial modernization legislation passed in 1999 allows banking organizations to directly invest in any type of company. This merchant banking authority gives banks greater opportunities to provide venture capital to start-up companies and later-stage equity financing to more mature firms. Kenneth Robinson examines how banks have pursued their new merchant banking powers. Robinson finds evidence that organizations that engage in merchant banking tend to be larger than those that do not. His findings are also consistent with the hypothesis that banks may be attempting to lower their average costs by combining merchant banking with other nonbank activities. Allowing banking organizations to pursue this new activity will provide them with an additional source of earnings and greater diversification opportunities and will likely increase private equity financing, which has been a vital component of economic activity.