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 are required to register with the Municipal Securities Rulemaking Board (MSRB), a self-regulatory organization which operates under oversight by the U.S. Securities and Exchange Commission (SEC).
- A dealer bank is a type of bank that buys and sells government debt securities.
- Dealer banks also engage in commercial banking activities such as issuing loans and collecting deposits.
- Certain dealer banks, known as “primary dealers”, are uniquely authorized to purchase U.S. government debt instruments directly from the Federal Reserve.
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.
The term “dealer bank” can also be used in a more general sense to refer to banks that sell securities from their own portfolio, regardless of whether those securities were purchased from a government agency. 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, for instance, many dealer banks suffered significant losses due to sudden declines in the value of CDOs linked to the then-plunging real estate sector.
Real World Example of a Dealer Bank
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”, play 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.