What is a Dealer Bank
A dealer bank is a commercial bank authorized to buy and sell government debt securities. Government debt securities include federal and municipal bonds which fund a variety of public initiatives including infrastructure improvement, road and bridge construction, and transportation projects.
Dealer banks must 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).
BREAKING DOWN Dealer Bank
Dealer banks operate across over-the-counter secondary markets selling government debt securities. Firms identified as dealers trade bonds and other securities by selling from their holdings or acquiring them to add to their assets. Some organizations such as investment banks or companies act not as a dealer, but as a broker. A broker is an intermediary between two parties wishing to trade financial assets such as bonds.
Although investment banks (IB) may deal in municipal and federal debt securities, dealer banks are unique in that they also are commercial banks. Some of largest commercial banks in the world are also dealer banks, including Bank of America, Citigroup and JP Morgan Chase.
Risk Exposure for Dealer Banks
The basis for traditional banking business is on receiving deposits for various types of savings accounts and then lending money to companies and individuals. Loans depend on the reserves held by the bank and available for lending. Some loans, like mortgages, are secured notes while others may be unsecured. The deposits held by the bank create stability by providing a cushion for a portion of loans that may default.
Dealer banks also buy and sell highly complex bonds and other securities which may be illiquid or thinly traded. In its dealer role, the bank has exposure to credit and collateral risks which may more resemble that of a securities dealer than a conventional bank.
For example, the dealer bank increases its risk when they extend a margin loan to a client in exchange for securities. The bank then allows another client to borrow that security to cover a short position. If too many market participants exit their trades, or short, simultaneously, the securities held and loaned, lose value which the banks' balance sheet may not reflect
Dealer banks may also buy and sell derivatives and collateralized debt obligations (CDOs). These instruments pool collateral in such a way that it is not easily analyzed or audited for risk potential. During volatile market conditions, this hidden risk can impact a bank’s balance sheet. Because of these complex risks, many dealer banks suffered significant losses during the 2008 financial crisis. Their declines were disproportionately more significant losses than at non-dealer banks.