IMPACT OF THE GRAMM-LEACH-BLILEY ACT ON THE FINANCIAL SERVICES INDUSTRY, THE

Journal of Economics and Finance, Fall 2004 by Mamun, Abdullah Al, Hassan, M Kabir, Lai, Van Son

Abstract

This paper examines the impact of Gramm-Leach-Bliley Act across three main sectors of the financial services industry: commercial banks, insurance companies, and brokerage firms, taking account of the wealth effect associated with the announcement. We find that the law has a differential impact across the financial services industry. All three industries have gained due to this law with commercial banks benefiting most, followed by the insurance industry. Further, the results show that larger firms benefited more in both the banking and insurance industries and exposure to systematic risk was reduced for all sectors of the financial services industry after this regulation passed. (JEL G20)

Introduction

This study examines the impact of the Financial Services Modernization Act or the GrammLeach-Bliley (GLB) Act of 1999 on the stockholder returns of the banking, insurance, and brokerage industries. It also examines the factors that can explain the returns associated with the important announcements and the impact of this law on exposure to systematic risk across the industries. We use financial market data to assess the impact of the deregulation.1 The GBL Act repealed the Glass-Steagall Act of 1933 and the Bank Holding Company Act of 1956 and allowed banks, brokerage firms, and insurance companies to merge.

The GLB Act did not fundamentally change the nature of the "mixing" of banking and other financial services but rather ratified and extended what was already being practiced as a result of the gradual liberalization of the Glass-Steagall restrictions. There are several studies that examine the major deregulations leading up to the GLB Act. For instance, Cornett, Ors, and Tehranian (2002) examine the performance of commercial banks around the establishment of a section 20 subsidiary. They find that the initial alliances of commercial banks and brokerage firms via the establishment of section 20 subsidiaries have been beneficial to commercial bank performance and allowed commercial banks to diversify their activities with increased performance relative to the risk being undertaken. Cyree (2000) finds similar results for commercial banks when the revenue limit from the investment banking activity increased from 10 percent to 25 percent of their total revenues. He finds that larger banks benefit more than smaller banks. Ely and Robinson (1998) analyze the wealth effect of an increase in the limit on banks' securities subsidiaries revenue from 10 percent to 25 percent on banking and securities firms. They find that this expansion has a positive wealth effect for most of the brokerage firms and banks, especially for banks that already have a securities subsidiary. Gande, Puri, and Saunders (1999) find that underwriting spread and ex-ante yields have declined significantly with bank entry into the corporate debt underwriting market. These effects are strongest among the lower-rated, smaller debt issues of which banks have underwritten a relatively greater share. They show that bank entry decreased market concentrations. Puri (1996) finds that investors are willing to pay higher prices for securities underwritten by banks rather than brokerage firms.

Several studies investigated the impact of the GLB Act on the financial services industry. Hendershott, Lee, and Tompkins (2002) find a significantly positive wealth effect of one event on both the insurance and brokerage industries; however, they do not find any wealth effect on commercial banks. They argue that loopholes in the laws have long allowed banks to have a "fairly substantial presence in other sectors" as a reason there is no wealth effect for commercial banks. For all three industries, they find that only the size of the firms explains the cross-sectional varation of wealth effect. Similarly, Carow and Heron (2002) find that brokerage firms and insurance companies benefit from the GLB Act but banks do not benefit. They also find negative returns for foreign banks, thrifts, and finance companies. Akhigbe and Whyte (2001), on the other hand, find that all three industries benefit from the provisions of the GLB Act. From the crosssectional analysis they find that larger and well-capitalized banks benefit more from this law; brokerage firms benefit regardless of size, but the gains are inversely related to capital position. However, insurance companies benefit regardless of size and capitalization.

Our study differs from and improves upon the existing studies in a number of ways. First, we examine a larger set of important events, some of which are ignored in previous studies and analyze a larger sample size. Schipper and Thompson (1983) suggest that event days with "material change" should be analyzed.2 second, we explicitly test a number of hypotheses regarding the differential impact of the GLB Act on commercial banks, brokerage firms, and insurance companies within a seemingly unrelated regression (SUR) framework, accounting for market risk, interest-rate risk, and foreign-exchange risk. Third, we also statistically test the validity of using SUR in comparison to OLS. Fourth, we examine the firm-specific determinants of the differential impact of the act in the same industries in a more detailed manner than previous studies.