Why are most brokerage firms owned by banks?

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A:

Most brokerage firms are owned by banks because this allows the banks to act as both brokers and dealers, and they have more resources at their disposal to weather market fluctuations. When banks execute transactions for an individual client, they are considered brokers. However, if they make trades on behalf of the bank as an entity, then they are considered dealers. Being able to act as both a broker and a dealer allows them more opportunities to profit.

Big banks generally have more money readily available than a standalone brokerage company, and they can sustain the big blows that comes with dips in the market. Independently owned brokerage firms tend to make more profit during boom times, but they also suffer greater losses during bear markets. So while investors may see more a more significant return on their money by going through an independent brokerage firm, working through a bank-owned firm actually provides more long-term security.

Another key difference between these two types of traders is that brokers are required to report the amount of commission they earn off of each trade. Dealers, on the other hand, can increase or decrease the amount of a security transaction without having to reveal the actual markup. Essentially, brokers simply facilitate sales and earn a commission for their work. They act as a middleman who matches up buyers with products and has nothing to do with pricing.

After the Great Recession that began in 2007, there was a backlash against bank-owned brokerage firms, because many had participated in predatory lending practices that focused on creating profits and not necessarily on benefiting their clients. As these unethical strategies came to light, many customers lost confidence in big banks. Many brokers also began to transition to independent brokerage firms in order to try to distance themselves from these events and earn back the trust of the public.

The Great Recession proved that even though large banks seemed to offer added security based simply on sheer size and resources, they were still capable of failing. Prior to the economic downturn, many pundits had described these institutions as "too big to fail," but their assumptions proved to be false during the mortgage crisis. The U.S. government stepped in and bailed out many of these companies by providing them with hefty loans. In addition, the government implemented new regulations in order to prevent these types of events from recurring and rebuild consumer confidence so that people would continue to invest through them.

Those looking to minimize risk in their investments should consider working with a bank-owned brokerage firm. However, there are concrete benefits associated with using independent brokers. In many cases, banks are the ones that benefit most from owning brokerage firms, not necessarily the clients.


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