A commercial bank takes deposits and issues loans to customers. An investment bank sells securities, investment instruments and provides advice on buyouts and mergers to corporations and large business clients. These two types of banking were kept separate by legislation from 1933 to 1999.
Separation of Banks
The United States Congress passed a piece of legislation known as the Glass-Steagall Act in 1933. This act, the GSA, separated investment banking and commercial banking. The intent of the bill was to prevent another financial crisis of the same magnitude as the Great Depression.
At the time the Glass-Steagall Act was passed, it was believed that unsafe banking practices involving the stock market set off the Great Depression. Large banks had become greedy and took on too much risk. Their goals and objectives were convoluted because banks engaged both in the issuing of securities and selling those securities to investors. The GSA aimed to change this by separating investment banks from commercial banks.
Did the Glass-Steagall Act Work?
Although many in the financial industry balked at the passage of the GSA, the act achieved its main objective of separating investment from commercial banks for more than 60 years. Banks had to choose whether they wanted to engage primarily in commercial banking or investment banking, and no more than 10 percent of commercial banks' profits could come from trading or investing in securities.
The Glass-Steagall Act was controversial from its very beginning, and faced opposition from the banking community. Foreign banks operating within the United States were not held to the same requirements as American banks. Many believed this gave foreign banks an advantage.
An End to Banking Separation
The legal requirements separating commercial and investment banking were dismantled in November 1999 when the Glass-Steagall Act was repealed with the passage of the Gramm-Leach-Bliley Act. Banks were again free to cross over and perform both investment and deposit functions.
- jar banking image by Yury Shirokov from Fotolia.com