Why are we still separating banking and commerce?

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In recent remarks, acting Comptroller of the Currency Keith Noreika suggested that the government should re-examine the historic separation of banking and commerce in federal law and regulation. He noted that the U.S. “is the only country” with such separation, and “it’s not the best thing to put all your eggs in one basket.”

Noreika is right. And while his agency is developing policy aimed at letting nonbank fintech firms into the banking system, his comments have even broader implications for allowing further linkages between financial and non-financial entities.

Thankfully, current policy makes removing the line between banking and commerce, once and for all, relatively straightforward. Sure, retailers are still blocked from owning bank holding companies — and the depositories they can own are limited — and BHCs cannot be or acquire retailers. For this reason, most observers of the banking industry still think that the policy rationale for separation is woven tightly into banking law.

But this is no longer true. The Gramm-Leach-Bliley Act of 1999 eliminated the basis for the separation principle. It’s only a matter of time before bankers and policymakers realize that concept no longer has any underlying policy support.

The separation of banking and commerce was always founded on a single idea — that if banks were allowed to affiliate with other businesses they would be induced to supply low-cost funding to their affiliates. This, it was thought, would give the affiliated firms a competitive advantage, and possibly encourage risky and concessionary loans to those affiliates — thus weakening the bank.

Sections 23A and 23B of the Federal Reserve Act, which require all transactions between banks and their affiliates to be at arm's length, were supposed to prevent transactions of this kind, but those who favored the separation principle continued to argue to Congress that these rules were not enough; the bank would find some way to assist an affiliate whatever the law prohibited.

However, Gramm-Leach-Bliley allowed BHCs to enter various nonbanking fields, such as securities underwriting and insurance. So Congress has now accepted the idea that banks could — complying with sections 23A and 23B — make loans to these businesses.

Accordingly, if under current law banks can safely make loans to financial affiliates without danger to competition or themselves, then the same should hold true for making loans to retailing affiliates. There is no difference in principle between an affiliation between a bank and a securities firm and an affiliation between a bank and, say, a retailer or manufacturer. If the former raises no issues of assisting an affiliate or weakening the bank, the latter shouldn’t either. This in effect eliminates the rationale for separating banking and nonfinancial (i.e., commercial) businesses.

Meanwhile, Noreika’s point about not putting “all your eggs in one basket” articulates another principle, which is stronger and more pervasive than the separation of banking and commerce: the only sure way to reduce risk in a rapidly changing economy is through diversification.

When banks are imprisoned within BHCs that can only engage in financial services they are made weaker, not stronger. If BHCs — that is, companies that control banks — were able to be or control companies in other growing sectors of the economy they would be better able to withstand the stresses of change that will occur in the future.

For example, the banking industry is now looking warily at the growth of fintech firms. This is simply an example of the changes in the U.S. economy that will inevitably occur as new and more efficient ways of communicating and funding businesses and consumers begin to compete with and challenge traditional relationships. In the future, banking will be faced with many more of these challenges, and some could be fatal for an industry that cannot expand its limited range of permissible affiliations.

More generally, banks need capital to operate and it is more expensive for stable or shrinking industries than for those that are growing. Because of past and current government regulatory policies, the banking industry is now dominated by four too-big-to-fail behemoths, while smaller entities — perhaps even more important for economic growth — struggle to keep their heads above water. If these smaller entities could affiliate with stronger local or regional businesses, they could acquire the capital to compete with larger banks.

And, finally, there is the possibility of bringing innovation to banking. At a time when IBM has acquired Promontory Financial and Amazon will acquire Whole Foods, tech firms and others could develop new ways to use the unique bank charter for growth. We don’t know what those changes will be, just as we can’t foresee how new methods of communication will change the world, but acting Comptroller Noreika is looking out for the long-term health of the industry by challenging an outdated construct.

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