The stock market is soaring, and sales of equity mutual funds are shooting through the roof. Prospects couldn't be brighter for the hundreds of banks that have staked out a place in investment product sales-right?
Well, maybe not.
Bank customers, long known for their risk-averse ways, have come around to investing in equity funds just as fears are rising that the market is due for a correction.
Now some observers are warning that bank brokerages could face a customer backlash if and when the correction comes-despite having dramatically expanded investment disclosures in the past four years.
"I don't see enough going on to inform investors" of the likelihood and effects of a market downturn, Donald Roberson, director of marketing and sales at Boston-based Funds Distributor Inc., said at a recent conference sponsored by American Banker.
While bank brokerages are preparing brokers for a possible drop in equities, he said, "I don't know if they (brokers) are communicating it to their customers."
Even banks that have been actively warning clients could face problems. "If it really does turn ugly, it won't matter how good a job you've done," said Geoffrey Bobroff, a mutual fund consultant based in East Greenwich, R.I. "Bank broker-dealers are being held to a much higher standard than they legitimately deserve to be."
To be sure, such criticism is at the margin. Even the critics give banks solid marks for having improved investment risk disclosures in recent years. And they say there is simply no way for banks to keep all their brokerage customers happy if the market falters.
Still, observers say fear of the unknown could be hindering frank discussions between bank brokers and their customers.
"It's a sensitive topic-everybody contemplates it, but no one wants to face it," said Keith F. Hartstein, senior vice president of the John Hancock Funds, Boston.
Anxieties about an impending market correction have been building for months, but worries have reached new levels in recent months as Washington officials have weighed in.
On Dec. 5, Federal Reserve Chairman Alan Greenspan spoke of "irrational exuberance" in the stock market, effectively serving notice that rising asset values are a legitimate part of the central bank's policy deliberations.
And on Feb. 26, Securities and Exchange Commission Chairman Arthur Levitt put the focus squarely on the novice investors who have flocked into stocks.
"Investors are not as informed as they should be. This is especially troubling because most of these new investors have experienced only a bull market. I fear that in a downturn those who don't understand risk may react precipitously and carelessly," he said.
Clearly, a market correction could upset equity investors at any brokerage-bank or nonbank. But banks are seen as particularly vulnerable, because they are still trying to balance a longtime reputation as trustworthy depositories with their new role as purveyors of investments.
Industry representatives say bankers are tuned in to the risks their customers face.
"I know it's an issue" among bankers, said Sarah A. (Sally) Miller, counsel for the American Bankers Association. If the stock market heads south, "everyone knows there'll be a lot more hand holding."
That's something banks are good at, said Mr. Hartstein of the John Hancock Funds. "When a customer has a trusting relationship, they're more likely to listen (to broker). That the advantage bankers have over "800" numbers at New York wire houses."
The challenge for bank brokerages is to keep investors from selling rashly, he added. "The worst thing you can do is panic and get out at precisely the wrong time."
Few banks were in the securities brokerage business during the major stock market corrections of 1987 and 1989. But most were around for the 1994 bond market crash, and that episode gave them a glimmer of how rough things can get.
The prospects of a downturn were widely discussed before it even happened, and many banks took steps to prepare customers. "A lot of banks sent out letters talking about interest rates and being ready for the long haul," recalled Ms. Miller.
Even so, customers unleashed a wave of lawsuits accusing bank brokerages of misleading sales practices-legal actions that the industry is still fighting. Some big banks-including BankAmerica Corp.-had to pump funds into money market mutual funds to keep them whole. And the regulatory climate suddenly turned icy, putting a chill on a business that had been seen as a promising source of fee income for banks.
Bank brokerages now labor under a battery of investment sales guidelines and regulations aimed at making sure customers understand that investments carry risks, and are not equivalent to insured deposits. More importantly, observers say, banks have learned from their experiences.
"Bank broker-dealers have made significant strides," said Michael W. Kellogg, executive vice president of the bank-services group at Fidelity Investment Institutional Services Co., Boston. "The 1994 bond market helped make them more aware. The business has grown."
Others say that investors have grown more aware of the risks, too. "The market is a hot topic," so it's easy for customers to hear a "word of caution," said Scott N. Degerberg, vice president and head of the Fountain Square mutual fund group at Fifth Third Bancorp., Cincinnati.
Still, there's no denying that a stock market downturn would be a new experience for many banks. Before 1994, few bank brokerages were selling stock mutual funds. By 1995, most were preaching the virtues of diversifying into equity funds. And by the end of 1996, stock funds were outselling bond funds at banks three-to-one, according to Financial Research Corp., Chicago.
