Is It Necessary to Combine Investment Banking and Commercial Banking?

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Submitted By dhilsh
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Is it necessary to combine Investment Banking and Commercial Banking?

Separation of Retail Banking and Investment Banking was a hot topic with President Obama’s proposal in January 2010 regarding a ban on US Banks on retail banks from using their own funds in investments and limiting to invest their customer’s funds. This news made many to wonder whether the world is going back to replace Glass Steagall Act which was abolished in 1999.(BBC,21January2010)

Glass-Steagall Act(GSA)commonly known as Banking Act 1933 made the investment banks and Commercial Banks to function separately in order to refrain Commercial Banks from greater in securities business activities. This Act prohibited Commercial Banks to underwrite securities to public while it prohibited Investment Banks to accept deposits from customers.
(Investopedia,2003).

Many argue that commercial banks should not involve in securities(stock/bond)market investments as commercial banks divert funds in investment banking. In other words internal transparency of movements of funds not very clear when operating as a ‘Universal Bank’. Prior to 2007-2009 financial crisis Commercial Banks were greedily involved merely because of profits in securitization business where subprime mortgages were involved. During the rise in property market in 2006,banks created and traded in securitized assets, backed by subprime mortgages. Banks became greedy of making more money through SPV(Special Purpose Vehicle)taking high risks. When borrowers start defaulting loans property price fell down resulting banks holding worthless properties. The main cause was these securitized assets were recorded as off-balance-sheet transactions..( Apostolik, R., et.al.,2008).

Banks misusing securitization was one reason why regulators require commercial banks and investment banks to function as two different units.

GSA was targeting to…...

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