Separation of Commercial and Investment Banks Activities and Its Impact on Economic Growth

Abstract

Economic growth of a country is depends on its financial system; banks contribute positively towards economic health and stability. Therefore, it is important for a country to have stable banking system, which is closely monitored and regulated by its legislative system. This need becomes even more relevant, when the episodes of financial crises are common (event of 1930 and 2007). From historical point of view in the U.S., the episode of financial crises in 1933 enforced the implementation of Glass-Steagall Act. The crash in stock market affected the banks; as a result, one out of every five banks failed (Crawford, 2011). Regulator and legislator questioned underwriting activities of commercial bank. They suspected that these activities caused a conflict of interest by suggesting their customers to buy securities from the bank where they have been written. These dubious activities contributed stock market crash and bank failures. Banks were given a choice to choose between commercial and investment banking activities (as part of Glass Steagall act) and a separation was enforced. Many had strong reservations against the act and after almost 66 years, the act was abolished. A new life was given to the banking sector in the U.S. and commercial banks were allowed to perform investment-banking activities. Once again, the history repeated itself in 2008 and global economy faced bigger crises then 1930 (Wilmarth, 2009). The regulator and legislator again asking question on the abolishment of Glass-Steagall Act and its justification.

This paper analyses two aspects. First, it analyzes the fact that both commercial and investment banks play a role in economic growth and failure in either of the banks could affect economic growth. Second, it discusses the hypothetical approach that the likelihood of having this impact on economic growth is bigger, when banks were allowed to mix their activities (As universal bank, due to changes in legislation and regulation in U.S.). As universal banks posses’ higher risk and were blamed to be the reason behind financial failure.

It was concluded that both the commercial and investment banks play a vital role in the economic growth of a country, the failure in either of them could affect economic growth. In addition, universal banks in U.S. (which came across due to changes in legislation and regulation) contribute towards recent financial crises; therefore, exert higher impact on economic growth.

Keywords: Glass Steagall Act, Banks, Commercial Bank, Investment Bank, Regulation, Legislation, Universal Bank, Economic Growth