Understanding the Financial Sector: Banks

Investment banking. This covers capital Market services, such as equity and debt issuance. This is often referred to as IPO activity.

Investment banking also provides merger and acquisitions (or M&A) advisory, where the investment bank will work with its big business clients to structure the purchase, sale or merger of one or more corporate entities.

Additionally, investment banks offer asset management (or investment advisory) to high net worth clients, including services that cover mutual funds , separate account management, private equity management and hedge fund management.

As we have seen with the demise of Bear Stearns BSC, investment banks can expose shareholders to great risk (see "Bear Stearns, Financial Investing and You").

However, risk and reward are intertwined, as these companies have the capacity to also generate huge profits when their operations are managed properly and economic conditions are right.

Aside from Bear Stearns, the largest investment banks are Goldman Sachs GS, Merrill Lynch MER, Morgan Stanley MS and Lehman Brothers LEH.

The Savings and Loans

Savings and loans (or S&Ls) are community-based banking institutions which tend to be concentrated in local geographic regions, such as cities or states -- although some have expanded across state lines.

These banks provide many of the same savings and checking services as the money center banks provide. However, S&Ls also provide funding for loans and mortgages to homeowners and small, businesses with a local focus

Many of the current S&Ls are survivors from the last banking crisis in the United States, which led to a government bailout engineered by the Resolution Trust Company (see "Five Lessons From the Mortgage Meltdown").

Since then, some of the current S&Ls got involved in "subprime" lending and mortgage-backed securities. This activity has dragged some, but not all, of the S&Ls directly into the current credit crisis.

Some of the largest S&Ls around today are Washington Mutual WM, Hudson City Bancorp HCBK, New York Community Bancorp NYB and Sovereign Bancorp SOV.

The Demise of the Glass-Steagall Act and You

In 1933 the Glass-Steagall Act was enacted as a measure to help prevent a reoccurrence of the failure of the banking system, which gave rise to the Great Depression . A significant component of that legislation was the separation of money center banking from investment banking and brokerage. As an example, JP Morgan had to separate its commercial bank from its investment bank, which became known as Morgan Stanley.

This all changed in 1999.

Under intense pressure from the money center banks and the investment banks, the Gramm-Leach-Bliley Act was enacted and Glass-Steagall was essentially repealed. As a result, the walls between money center banks and investment banks were broken and many of those institutions began to provide services across the whole banking spectrum.

So today, we see Citi acting as a money center bank, an investment bank and a broker-dealer. Some might argue that it was Gramm-Leach-Bliley that created the environment that led to the credit market crisis that we're combating today, and that if Glass-Steagall was still operable it would have prevented the current "crunch."

The financial sub-sectors and banks discussed in this lesson are those which are most impacted by the current credit market crisis. Other groups and companies have also felt the sting of the decline of the housing and mortgage markets, while some are relatively unaffected.

Next, we'll take a look at insurance companies.

In the meantime, review your portfolio and identify any banks that you might own. Then determine which category they fall into and what risks might be associated with holding them. This same homework applies if you don't own a bank stock right now, but are considering investing in one.

To stay up to date on the banks, bookmark and visit TheStreet.com's Financial Services section.