Dealer Bank

What Is a Dealer Bank?

A dealer bank is a commercial bank that is authorized to buy and sell government debt securities. Examples of such securities include federal and municipal bonds, which are used to fund various public initiatives such as infrastructure spending and general government expenditures.

Dealer banks in the U.S. are required to register with the Municipal Securities Rulemaking Board (MSRB), a self-regulatory organization that operates under oversight by the U.S. Securities and Exchange Commission (SEC). Many other countries also utilize a primary dealer system to buy government bonds from their respective central banks.

Key Takeaways

  • A dealer bank is a type of bank that buys and sells securities.
  • Dealer banks also engage in commercial banking activities such as issuing loans and collecting deposits.
  • Broker-Dealers (BDs) are a type of dealer bank that also fills orders for customers.
  • Certain dealer banks, known as “primary dealers”, are uniquely authorized to purchase U.S. government debt instruments directly from the Federal Reserve.
  • Primary dealers also operate to distribute sovereign debt from their respective central banks in other countries.

How Dealer Banks Work

Dealer banks play an important role in the capital markets because they help to facilitate the government’s fundraising activities. If a municipal government wants to raise funds by issuing a municipal bond, they might sell that bond to a network of dealer banks who would then, in turn, resell those securities to the investing public. The dealer bank’s customers could range in size from large institutional investors, such as pension funds and other financial firms, to individual retail investors.

Dealer banks earn their profit by marking up the resale price of the government securities that they purchase. On the other hand, they also assume the risk of not being able to sell those securities at a profitable price. In this sense, they act as a kind of reseller of the government’s debt securities, bridging the gap between the government and the investing public.

At the same time, dealer banks are also engaged in traditional banking activities such as taking customers’ deposits and lending out money to companies and individuals. This means they enjoy other revenue streams, such as the interest income earned on mortgages, lines of credit, and credit cards.

Special Considerations

The term “dealer bank” can also be used in a more general sense to refer to banks that sell securities from their own portfolio (often on behalf of clients), regardless of whether those securities were purchased from a government agency. These are sometimes known as broker-dealers (BDs).

For example, some dealer banks buy and sell collateralized debt obligations (CDOs) and other derivative products. These types of securities generally carry much higher risks than government debt instruments, and often have relatively few customers.

This can make it difficult to accurately price these securities, occasionally leading to significant losses.

During the 2007-2008 financial crisis, many dealer banks suffered significant losses due to sudden declines in the value of CDOs linked to the then-plunging real estate sector.

Primary Dealers

Well-known examples of dealer banks include J.P. Morgan Securities LLC (JPM), Bank of America Securities, Inc. (BAC), and Wells Fargo Securities, LLC. (WFC). In addition to their regular commercial banking operations, these banks all buy and sell government securities such as the bonds issued by state and municipal governments.

In addition, these banks are also part of an elite group of roughly two-dozen institutions that are authorized to buy U.S. government debt directly from the Federal Reserve. This group, collectively known as “primary dealers,” plays a kind of wholesaling role for U.S. government debt throughout the world. Because of the centrality of the U.S. dollar (USD) in the world economy, these prime dealers are important institutions in the global banking system.

A primary dealer needs to sustain minimum capital requirements ranging from $50 million for non-banks to $1 billion of Tier 1 capital for banks. Broker-dealers applying for a spot in the primary dealer system must register with the Securities and Exchange Commission (SEC) or the Financial Industry Regulatory Authority (FINRA).

The Fed collects data from the primary dealers and disseminates reports for the public, documenting the amount of federal debt issuance.

What Is a Broker-Dealer?

A broker-dealer (BD) is a financial firm that trades securities from its own account for its own proprietary trading or on behalf of its clients. A broker-dealer can therefore act as both principal and agent on a trade, depending on the circumstances.

What Is a Dealer Account?

A dealer account refers to the portfolio or holdings of a dealer bank. For primary dealers, this may also include an account established at the central bank in order to purchase Treasuries.

What Is the Difference Between a Broker and a Dealer?

In general, a broker acts on behalf of a client as an agent to facilitate a buy or sell order with an interested seller or buyer, as the case may be. A dealer, on the other hand, trades with customers securities from their own account, where they act as principal.

How Do Primary Dealers Make Money?

Primary dealers purchase government debt directly in order to resell those bonds to investors at a slight mark-up, which is how they earn a profit.

Article Sources

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  1. Municipal Securities Rulemaking Board (MSRB). "Overview of MSRB Rules," Page 1. Accessed Dec. 21, 2021.

  2. Federal Reserve Bank of New York. "Primary Dealers," Click on "Current List, Additions, Removals & Name Changes." Accessed Dec. 21, 2021.

  3. Federal Reserve Bank of New York. "Primary Dealers." Accessed Dec. 21, 2021.

  4. Federal Reserve Bank of New York. "FAQs About the New York Fed's Counterparty Framework for Market Operations." Accessed Dec. 21, 2021.

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