The Business of Banking: Before and after Gramm-Leach-Bliley
Posted: 5 Jan 2001
This Article explains the economic nature of the services that banks provide. On the liability side of the balance sheet, banks' demand deposit accounts are shown to offer depositors a form of liquidity insurance. Rival providers of liquidity, such as money market mutual funds, offer services that are economically distinct from the transactions services offered by banks. These rival services are not perfect substitutes for the services that banks provide. Similarly, on the asset side of banks' balance sheets, banks specialize in offering close, finely textured monitoring to borrowers. This monitoring service not only is of value to firms and individuals that do not have access to public debt markets, but also to all firms that face moral hazard when borrowing. Bank lending provides credible assurances to other investors that the borrower will receive continuous monitoring. Thus, bank lending lowers borrowers' overall capital costs. This analysis shows that banks serve a distinct and important economic role and challenges the commonly held view that commercial banking is a declining industry whose core functions are being supplanted by securitization and other technological and financial innovations. The recent reforms of the financial services industry are examined within this analytical framework. The Article disputes the popular view that Gramm-Leach-Bliley was necessary in order to permit banking organizations to reduce their dependence on traditional commercial banking activities that are becoming obsolete. The Article argues that a more plausible explanation for Gramm-Leach-Bliley is that the statute was passed because it served the interest of large financial conglomerates, particularly investment banks, who wanted to enter the profitable field of commercial banking.
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