THE latest Wall Street merger has created an investment bank that could trample on its rivals. The merger of the US investment bank Morgan Stanley and the US retail brokerage and credit card company Dean Witter Discover is not simply a significant event for the American securities industry, it could also have repercussions for banks, brokers and fund managers around the world.

The merged company is most obviously a response to what has been the unexpected success in recent years of Merrill Lynch, the largest US retail broker. Merrill's "thundering herd" of local salesmen have been combined with an institutional broking arm to make a strong investment bank.

It also poses a big challenge to banks, led by J.P. Morgan, that have tried to build investment banking operations on top of lending businesses. As the traditional boundaries between US banks and securities firms have weakened, this has often appeared the most likely model for the future.

This is not merely an issue for participants in the US. The biggest US investment banks - notably Morgan Stanley, Merrill Lynch and Goldman Sachs - have developed strong international operations. By reinforcing its powers to sell securities in the US, Morgan Stanley may gain an extra edge.

"I think this is a fascinating deal. Unlike many other mergers it's not one of consolidation, but of complementary expansion," says Mr James Quella, a director of Mercer management consultants in New York. "There is now a competitor for Merrill, which has never existed before.

Even three years ago, the notion that retail brokers in the US could be an essential part of a global investment bank would have seemed a strange idea. Not only did they have a poor image, but the cultural problems in combining them with investment banks had proved immense.

The most notable example was the combination of Shearson, the retail broker, with Lehman Brothers, the Wall Street bank, under the ownership of American Express. This was dissolved three years ago after cultural differences between the two sides prevented them working together.

Yet this was also a poor period for the retail broking industry. Since then, inflows of cash into mutual funds - open-ended pooled investments similar to UK unit trusts - have been so strong that investment banks have realised the best growth prospects are in the retail market.

Last year, mutual funds took in a total $324.9 billion (£203 billion) in net new cash flow, almost $100 billion more than the previous record. Thanks to "401(k)" plans - individual retirement plans which are sponsored by companies - mutual funds are also making inroads into the institutional market.

With its acquisition of Dean Witter's fund business, which had $77.47 billion under management at the same time, the new merged company will become only the sixth company to hold more than $100 billion in mutual fund assets and will gain significant benefits of scale.

Morgan Stanley now has access to Dean Witter's huge retail brokerage sales force, which numbers about 8,500, and ranks third. Combined with Morgan Stanley's much smaller force of 2,570 brokers, the new company will be of similar scale to Smith Barney, with 11,105 brokers. It will help to stave off the increasing threat from commercial banks.

Morgan Stanley has come to this merger after having signalled for some time it was looking to consolidate its position in fund management and securities. Its failed attempt in late 1994 to merge with S.G. Warburg Group, the European investment bank later taken over by Swiss Bank Corporation, was its most significant move.

The Dean Witter merger is of a different kind. As Mr John Mack, Morgan Stanley's president, said yesterday, a Warburg merger would have led to the elimination of overlaps between the two firms. "It was almost a negative because everybody had a cloud over them. The exciting thing in this story is that everyone has a chance to grow the business," Mr Mack said.

The logic for the Dean Witter network is that it will be able to sell US retail investors both securities issues underwritten by Morgan Stanley and international mutual funds. In turn, Morgan Stanley should be able to market its new strength in retail distribution to overseas issuers.

Yet for all the apparent logic of the deal, there are still considerable questions about making it work. For a start, the company will be a new animal, combining retail brokerage and fund management with a credit card company and a classic investment bank concentrating on institutions.

Furthermore, the cultural gap between retail brokers and institutional investment bankers remains large. "There are substantial operating and cultural risks in mergers of this sort. Some of them work, but others don't," says one senior investment banker.

Assuming the roles of senior management can be worked, the combined company clearly poses a challenge to competitors. One set of financial institutions that will be looking at the new force carefully are investment banks such as Goldman Sachs that lack such a strong retail distribution arm.

"One would be remiss if one did not think carefully about how consolidation of this sort affects us, but we have a very cohesive plan and culture that is successful today and will be successful going forward," insists Mr Jon Corzine, Goldman's chairman. Nonetheless, Goldman and others may have to accelerate plans to expand in mutual fund management.

On the other side of the industry are the commercial banks led by J.P. Morgan that have been trying to build up their investment banking arms. European banks such as Union Bank of Switzerland and Deutsche Bank have also been trying to build such operations both in the US and in Europe.

Until now, such institutions were thought most likely to be able to claim the title of "the pre-eminent global financial services firm" boasted by the participants in yesterday's deal. As the regulatory divide between banks and securities houses in the US lowers, these banks have been seen as powerful new competitors to Wall Street firms.

Yet this deal at least gives a fighting chance to the sort of combined retail and institutional brokerage that was until now represented only by Merrill Lynch.