Will Glass-Steagall Pass Through the Back Door?

August 7, 2013

Reuters ImageIt’s remarkable how far two little words can go in a short amount of time.  Until 2010, when the US government was picking up the pieces from the financial crisis and reassessing how banking and finance should be regulated, the words Glass-Steagall were common parlance for only a relatively obscure group of banking lawyers.   Now those words are ubiquitous, from daily headlines in major newspapers to the placards of Occupy Wall Street protesters.  Glass-Steagall even received fifteen seconds of fame on the hip HBO series Girls (when bohemian artist Jessa learns that her friend does not know about Glass-Steagall, she admonishes her to read the news more often).  Suddenly a fusty old statute from the 1930s has reemerged in many eyes as the nation’s resurrected savior.

The provision in question is the ban on affiliations between depository institutions and “securities firms.”  Until it was revoked under the Gramm-Leach-Bliley Act of 1999, it ensured a nearly iron-clad separation between the nation’s commercial and investment banks.  By 1999, following decades of vast technological and other changes in the financial industry, the separation no longer seemed useful. Indeed, to many, it threatened the very competiveness of the US.  But since the crisis and the controversial government bailout of the financial industry that ensued, many, including perhaps most surprisingly, former Citibank CEO Sandy Weill, have called for a reassessment of that ban.

Despite these calls, I do not think we will see the return of a clear line separating banking and investment activities.  The most recent call to reinstate a form of Glass-Steagall, although penned by two political heavy hitters, John McCain and Elizabeth Warren, has been dismissed by most in the industry as DOA.   What I think we may see, indeed we may already be witnessing it, is a set of powerful regulatory measures to persuade the nation’s banks to focus on their core business of banking and to offload  their riskier investment activities.   These include:

  • The Basel III reforms, recently finalized in the US, which will require banks to hold more and higher-quality capital against their assets, and will, by virtue of risk-weight recalibrations, impose significantly higher capital requirements on many of their non-core banking activities.
  • A set of measures requiring banks to account for their off-balance sheet exposures (e.g., special purpose vehicles) and swaps and derivatives activities when determining compliance with their regulatory requirements.  Traditionally, these are where banks have engaged in some of their riskiest investments.
  • A slew of enhanced “prudential requirements” on the largest US banks, including enhanced capital and liquidity requirements.

Finally, the Volcker Rule, expected to be finalized later this year, represents at least in part a form of “Glass-Steagall Lite.”  It will prohibit, subject to certain exceptions, banking organizations from engaging in proprietary trading or sponsoring or investing in private equity and hedge funds.

Importantly, some, though certainly not all, of these measures are being adopted in Europe and other major centers of finance.

We may already be seeing proof of this invisible Glass-Steagall working its hand through the marketplace. In a recent global survey conducted by The Institute of International Finance and Ernst & Young, almost half of the banks surveyed said that they were already shedding several lines of business and refocusing on their core banking activities due to regulatory pressures (citing, in particular, the new requirements under Basel III).

So, while we may not see Glass-Steagall back on the law books anytime soon, banks can expect a regulatory terrain that will, at the very least, make ventures outside of traditional banking rather uncomfortable.