The Structure of the U.S. Banking System
Introduction
During the recent global financial crisis, critics have posed the question: does the repeal of Glass-Steagall have a positive or negative effect on the banking industry? Review of the structure of the U.S. banking system has culminated in some consensus that the U.S. government should bring back the Glass-Steagall Act. This is consistent with reporting by the FDIC (Federal Deposit Insurance Corporation), that more than one hundred twenty banking institutions have failed between 2007 and 2009, and this was largely in part due to high risk investments (i.e. mortgage backed securities).
First enacted in 1932 the Glass-Steagall Act laid forth the provision for separation of commercial and investment banking. The initial legislation instituted rules to federal bookkeeping outlining the framework to control of Treasury accounting in order to balance the national banking administration’s account. Amendment of the 1932 Act in 1933 under the same name, established the separation of financial institutions according to function, distancing banking activity and protocol from oversight of the Securities and Exchange Commission (SEC).
The 1933 change created limited measures for Federal Reserve governance of securities trading. Resultant to this legislation, banks were subject to liquidity constraints, thus restricting a monopoly by any one institution. In 1935, the Act was amended again, enacting what is known as the Banking Act.
In 1956, Congressional enforcement of new banking rules in the Bank Holding Act furthered the size restrictions of institutions, making institutions responsive to restrictions in formation of financial services conglomerates. Similar to the Glass-Steagall Act 1933, the 1956 legislation created separation between banking and insurance activity; and this was in direct response to a series of “aggressive acquisitions and expansion by TransAmerica Corp., an insurance company” (Cftech, 1998).
The parent of Bank of America’s holdings and other wholly owned subsidiaries, the insurance giant’s transaction relationship with financial institutions brought risk of losses underwriting to the fore. This rule continues to be in effect in the United States.
The Critics
In 1999 the enactment of the Gramm–Leach–Bliley Act repealed the Banking Act. Evidence of constraints on capitalization it was eventually proven, cost those institutions and the national economy significant liquidity in trading. Prior to the repeal, expansion of Section 20 to the Act in designation of new rules to affiliate activities in response to Congressional review of the merger of Citicorp and Travelers companies paved the way for major transformation of structure of U.S. banking institutions. New legislation dedicated to acquisition, structuring and control of commercial affiliations was enacted in 1997 and 1998.
The outcome of nearly sixty six years of debate about the banking structure legislation resulted, finally, in repeal. Since the repeal, subsequent devolutions of market stability have served as a touchstone for new public opinion that the early 20th legislation should be re-enacted in order to better manage risk.
The FDIC
When Federal Deposit and Insurance Commission (FDIC) Chairman, William Isaac issued the announcement that “that state chartered non-Federal Reserve member banks could establish subsidiaries to underwrite and deal in securities” in 1982, the policy statement reinforced the Office of Comptroller and Currency (OCC), Comptroller, Todd Conover decision to approve mutual fund companies and retailers to establish “nonbank bank” subsidiaries outside of the rules of the Bank Holding Company Act (Wikipedia, 2010).
Counter response by the FDIC later by Chairman Paul Volker in a Congressional plea to overrule both the earlier FDIC and OCC actions in new legislation confirmed that the Glass–Steagall Act did not delineated between state chartered non-Federal Reserve System member banks and securities firms; even where a bank was FDIC insured (Wikipedia, 2010).
Much of the debate surrounding the volley in FDIC legislative activity in 1982, focused on rule enforcement of the International Banking Act 1978.
The international policy designed to allow for foreign banks to establish US branches under Glass–Steagall, required “grandfathering” of those entities; permitting retention of existing holdings. The loophole within U.S. law also allowed for foreign banking institutions to own a controlling interest in U.S. securities firms. As large banks sought to free their investment potential from restriction, support for the repeal grew.
Conclusion
Critics are divided on the question of whether the US government bring back the Glass-Steagall Act. During the global financial crisis of 2008, commencing with the U.S. mortgage lending industry crisis of 2007, illustrated the incredible level of risk attached to both primary and secondary market investment activities. The clear separation of commercial banking and investment institutions is still widely recognized in practice by financial organizations, yet the flexibility of rules to transactions leading up to the crisis shows that too few controls on trading and other portfolio activities indeed, posed imminent threat to those companies and their clients.
The 1982 FDIC and OCC decisions and subsequent rule reversals offer important insight into the loopholes present within U.S. banking structure(s).
Application of the rule to affiliated institutions stood in the place of financial services stipulations, if the nonbank bank evidenced it was 1) a national bank, or 2) otherwise a member of the Federal Reserve System (Wikipedia, 2010). Mutual companies were perceived to be a third term to this rule split in the OCC decision.
The argument that mutual companies earned only a small portion of their revenues from insurance underwriting and share distribution in mutual funds supported this claim. Some companies also established state chartered, non-Federal Reserve System member banks to circumvent Glass–Steagall constraints on affiliation status between member banks and securities firms.
Preface to the OCC’s action was the Bank Holding Company Act (BHCA) providing that companies must be commercial lending institutions to be acknowledged by the FDIC as “bank holding companies” under law. New “nonbank bank” entities might be established based on separation of their internal financial service menus; “checking accounts (but not commercial loans) or commercial loans (but not checking accounts)” (Wikipedia, 2010). Under this rule, restrictions to the Glass–Steagall were enforced. Had those restrictions still been in place in 2007, the impact of U.S. banking, financial and insurance companies on the global crisis may have been different.
References
Commercial Bank (2010). Wikipedia. Retrieved from: http://en.wikipedia.org/wiki/Commercial_bank
Federal Reserve (2002). The Banking Industry in 2002 after a Decade of Change. Retrieved from: http://www.federalreserve.gov/BoardDocs/speeches/2002/200211124/default.htm
The Gramm-Leach-Bliley Act (2010). Wikipedia. Retrieved from: http://en.wikipedia.org/wiki/Gramm-Leach-Bliley_Act
Understanding how Glass-Steagall Act impacts investment banking and the role of commercial banks (1998). Cftech. Retrieved from: http://www.cftech.com/BrainBank/SPECIALREPORTS/GlassSteagall.html
Understanding how Glass-Steagall Act impacts investment Banking and the role of commercial banks. (n.d.). Ratical. Retrieved from: http://www.ratical.org/co-globalize/linkscopy/GlassSteagall.html
What is an Investment Bank? (n.d.). Vu.union.edu. Retrieved from: http://www.vu.union.edu/~sif/Investment%20Banking.pdf
