Mr. Krainer starts his analysis of the Act’s consequences by asking two questions. First, why might banks and commercial firms want to unite — would this create new operating, funding, and informational efficiencies? Second, why are lawmakers so afraid of allowing unions of banks and commercial enterprises?
Under the GLB Act, banks can, for the first time, set up merchant banking subsidiaries to make short-term investments in non-bank enterprises. But financial holding companies still have to get approval from the Federal Reserve Board if they want to invest in other companies, and these investments will be vetoed if they are seen as speculative ones that threaten deposits.
According to Mr. Krainer, there are major loopholes in the new legislation. Banks are free to contract out surplus capacity to outside, non-bank vendors. They can lease space inside their branches to coffee shops and use surplus broadband capacity to create Internet service providers. Moreover, “unitary thrift companies” — holding companies that control only one savings bank — will continue to operate. This ensures that such large firms as Ford Motor Company and Sears, Roebuck and Company, which entered the financial services industry in the 1980s by exploiting the unitary thrift loophole, can maintain their banking subsidiaries.
But suppose that banks were completely free to make outside commercial investments. Wouldn’t a bank use its considerable capital to favor firms it invests in over those firms’ rivals? Mr. Krainer contends that it’s debatable how much clout banks really have over credit and capital. In the 1990s, the number of banks declined while the number of non-bank lenders steadily rose. So it’s probable that competitors to bank-controlled firms have ready access to credit from non-bank financial lenders.
Other laws, most notably sections 23A and 23B of the Bank Holding Company Act, help preserve the safety of deposits by restricting loans made to non-bank subsidiaries to 10 percent or less of a bank’s deposits. These regulations would remain in force if restrictions on non-bank investments were eased.
Part of the deregulation resulting from Gramm-Leach-Bliley allows banks to create subsidiaries for venture capital and merchant banking. Thus, it’s less likely that banks would want to have long-term investments in other companies, even if prohibitions were removed. As a result, Mr. Krainer predicts, “the benefits of allowing banks and commercial firms to mingle are not likely to be huge” — and the prohibitions against such mingling are increasingly irrelevant.