Narrow Banking as a Structural Remedy for the Problem of Systemic Risk: A Comment on Professor Schwarcz's Ring-Fencing

Abstract

In a recent article, Professor Steven Schwarcz describes the concept of "ring-fencing" as a "potential regulatory solution to problems in banking, finance, public utilities, and insurance." Ring-fencing has gained particular prominence in recent years as a strategy for limiting the systemic risk of large financial conglomerates (also known as "universal banks"). Professor Schwarcz’s article describes several ring-fencing plans that have been adopted or proposed in the United States, the United Kingdom, and the European Union.

This Comment argues that "narrow banking" is a highly promising ring-fencing remedy for the risks created by universal banks. As the Comment explains, narrow banking would strictly separate the deposit-taking function of universal banks from their capital markets activities. If properly implemented, narrow banking could significantly reduce the safety net subsidies currently exploited by large financial conglomerates and thereby diminish their incentives for excessive risk-taking.

Keywords: Dodd-Frank Act, financial conglomerates, Glass-Steagall Act, narrow banking, ring-fencing, systemically important financial institutions, systemic risk, too big to fail, universal banks

JEL Classification: E44, E53, E58, G18, G20, G21, G24, G28, K20, K23