Question

Discuss the reasons broker-dealers tend to hold less equity capital than commercial banks.

Answer 1

Broker-dealers are the intermediaries that help in the trade of financial securities. Broker-dealers may be individual or in the form of a firm that facilitates the trade of securities on behalf of investors. Whereas commercial banks refer to such financial institutions that accept deposits and grant loans for various purposes.

When the purpose of both broker-dealers and commercial banks are quite different then the capital structure of these financial bodies also differs because commercial banks deal in short-term and long-term financial matter whereas broker-dealers normally deal in short-term financial matters. That is why broker-dealers normally hold less equity capital compared to commercial banks.

Broker-dealers work on behalf of investors and normally face short-term financial shortage and surplus, that is why it does not look logical to hold higher equity capital compared to commercial banks. Broker-dealers fulfill most of the financial requirements through short-term borrowings whereas commercial banks need short-term and long-term fundings because such banks may lend money for long-term purposes and due to such long-term borrowing carrying more equity capital becomes necessary. But this condition is not true in case of broker-dealers, that is why they hold less equity capital and save unnecessary financial charges on such long-term based fundings.