Depository Institutions and investment Banks regulations

The banking system plays a very important role in the economy as it offers various regulatory measurers that assist in the running of this industry. The purpose of this literature review is to identify how depository institutions and the investment banks have been regulated by using the Glass-Seagall Act (1933) and how it needed to be amended via the Gramm-Leach-Bliley Act. The Acts further define the business ethics that govern these financial institutions.

In addition, they illustrate further how the removal of some of the limits has affected business operations and the economy. This is helpful as the major areas that need improvement can be identified thus creating room for ways and policies that can be developed to enhance the progress of these institutions. Congress can use such measurers as a way of salvaging the failing economy. Introduction Financial Regulations is important in business as it enhances the stability of the country through the various monetary policies in place.

This regulation is important as it enables business to act in proper manners in ensuring the safety of the financial assets and investments of businesses and individuals. The objectives of financial regulation therefore entail enhancing safety and soundness of the system through the enactment of proper policies and monitoring of depository institutions. This is important as it enhances consumer and investor protection. The current financial structures are complex ether in terms of their formation, legal restrictions and understanding the policies that govern the country.

It is therefore important that the consumers and investors are protected against potential fraudulent schemes. This enhances fairness by proper allocation of resources and setting of laws against discriminatory lending practices that has contributed to the collapse of some organizations. Literature Review Several regulations have been used to govern the way investment banks and depository institutions work in the United States of America.

For example, the International Banking Act (1978), the Depository Institutions Deregulation and Monetary Control which was followed under the Regulation Q specifications and the Garn-st. Germain Depository Institutions Act (1982) which enhanced the lending capabilities of the institutions, the ability of some institutions to purchase failed saving banks and distribute insurance. One of the major banking legislations that was enacted was the Glass-Steagall Act (Banking Act) of 1933.

this Act was used to disallow commercial banks from underwriting securities apart from the state bonds which included the municipal and government bonds as well as loans made on real estates. In addition, the Glass Steagall Act (GSA) was used to form the Federal Deposit Insurance Corporation and banking policy improvements that would aid in monitoring the controls of the country’s financial institutions (Greene, 2005). This Act was important as it was designed to assist the treasury in balancing its books of account.

The Glass-Steagall Acts was supported by the Carter glass and Henry Steagall democrats and was the first Act that was passed in 1932 with the aim of controlling deflation and giving the federal the ability to lower their interest rates in the banks so that they are in a position to offer government bonds to the public(Cohen, 1985). The GSA was formed at a time when the U. S economy was under one of its worst depressions at that time. The banking system had failed; characterized by some banks closing, which led to the loss of jobs.

A revolution needed to be made in order to restructure the banking system and the Glass-Seagall Act (1933) made this possible. “The GSA (1933); the second act, was put in place so that it could help in the restructuring of the economy when most of the commercial banks in the country were collapsing (Rosenthal et al, 1988). ” This can be likened to some of the financial problems that are being experienced in the country today. Most of the problems; then, were attributed to the collapse of the stock market such that foreign investment also reduced.

Fraud by the stock securities also contributed to the collapse. The GSA enhanced the Federal Reserve System to accept currency other than the gold backed currency thus creating a new system of financial governance in the country that is also being used today. Why the Glass-Steagall Act was necessary It separated commercial banking and investment except in areas with regard to treasury securities, the general municipal bonds and private debt and equity securities. Investment banking was and is still considered risky and that is why this regulation was necessary.

“Sections 16 and 21 address the roles that commercial banks such that they also restricted them from participating in the issue or purchasing of stocks with exceptions made in the government bonds (Czyrnik, 2001). ” It was necessary to separate the commercial and investment banking because: The separation minimized the risks of loses that the organizations had to deal with. This was because the banks that engaged themselves in underwriting had incurred huge losses and the government had to support them financially thus using money that was supposed to be channeled to other necessary sectors of the economy such as education and health.

If this would have continued over a long period, the government would have to limit the funds that are loaned out and this would have meant that the public would have lost trust in the banking system. Minimized conflicts of interest. The separation of the banks and investment was necessary because it was observed that when banks decided to undertake in other business ventures, they would always want to please both p[arties and in some cases this was impossible thus resulting in conflicts which were never resolved on time. The people who were mainly affected by such acts were the customers.

“The separation was necessary so that improper banking activities could be minimized (Khambata, 1996). ” Even if there banks tried to adhere to the law so as to keep the various abuses minimal, still the way the investments are run cannot be compared to the banking system and linking the two was seen as complicating the system. Separating the investments and commercial banking was good because it meant that federal state was only going to support the banks that are protected under it and not taken advantage of by other financial institutions whose debts are as a result of other activities that the state is not entitled to support.

“In addition, the division between the investment and banking would lessen the powers that would have emerged when the underwriting firms intensify their competition and supersede commercial banks through unfair competitive practices (Canals, 1997). ” If banking and investment were not separated, this would mean that the banking system would not be specialized and this means that the in the long run, customers and the economy would be affected. This may be attributed to the cause of the current banking system failure as the Act was replaced and the depository institutions and investment banks were separated.

The Federal Reserve was allowed to regulate interest rates and this was because the Regulation Q allowed it to do so. Banks expansion operations were limited such that they were regulated from investing in other financial companies and this was enacted into law in 1980 under the Depository Institutions Deregulation and Monetary Control Act. The Gramm ¬Leach-Bliley Act was created in 1999 to enable the banks acquire other banks. Initially the financial system performed all the banking functions and this included investments.

The GSA was important as is it separated the two and this was good for business as it enabled the banks and investment banks to be run efficiently. This made the US banking system stronger. Another reason why the act needed to be kept was because the depository institutions had a lot of authority as they control their client’s funds. This power needed to be minimized so as to enable competition in the financial market. Investment in stocks was and still is risky in business and this could affect the deposits.

The government which is in control of money in the economy will therefore be left to compensate investors for the losses that may result when the depository institutions may face. Moreover, depository institutions are able to control the risks that may affect the financial institutions. This means that competent managers are needed to undertake such tasks and the GSA allows them to them to do so thus enhancing the stability of the financial market and the economy in general. This will in turn attract more investments that will provide enough capital for the business to be able to operate effectively.

The House of Commons abolished the Glass-Steagall Act because by Phil Gramm; the Senate of Texas. For a number of reasons which included: The first reason was that the abolishment of the Act enabled the depository institutions to operate in properly regulated financial systems. This is because the Glass-Steagall Act did not clearly demarcate between loans, investment stocks and deposits in its law and how they out to have been treated (Canals, 1997). This meant that people were losing their investments especially in the firms that were not well controlled as well as foreign institutions whose provisions were not included in the law.

Moreover, there were conflicts in the way credit was offered to customers and businesses and how this credit was used in investment. The investment banks did not lay down the policies with regards to the usage of credit and how they were loaned out and the investment banks sometimes acted in their own interest without thinking how they were affecting their clients. Another reason was that the securities in the depository institutions were very risky and this would mean that the organizations that dealt in them risked to be affected negatively as a result of any economic changes (Laird, 1998).

Another reason was that; since the depository system always worked in unison with the banking and the security markets, the new Act would enable the financial institutions to learn from the various loopholes in the GSA and this would make them keener in avoiding the underlying causes of collapse of the country’s financial system. The Glass-Steagall was also not seen as a major governing tool therefore it could be easily eliminated without affecting the financial institutions thus encouraging competition in the industry (Laird, 1998)..

This is because through it enhanced banking and trade transactions, various loopholes in other acts could be used to achieve the same goals. for instance the laws that regulate saving institutions. Why change was needed in the banking sector Legislators have always tried to promote the growth of the banking industry by enacting certain laws that enhanced the expansion of the business. In the 1930s and 1940s, banks dealt mainly with deposits and issuing loans and more needed to enhance the growth of the banking industry.

The Bank Holding Company Act tried to reduce these powers by creating regulations in banking and insurance so as to limit the expansion activities of banking institutions. Congress also saw that the banks were taking risks that would result in huge losses not only for themselves but also the economy (Markham, 2002). Moreover, big financial companies at that time were seen as the cause of the financial problem and that is why some of their services were minimized as a way of preventing the banks from using their clients’ deposits when they had limited funds (Heakal, 2009).

Flexibility of the GSA was seen to have contributed to the failure of most American banks. The banking sector wanted the Glass-Steagall Act to be abolished as it restricted some of the activities if saving banks and investment banks. These issues were presented to the House of Representatives by Phil Gramm; Texas senate. The House reviewed the Financial Services Act (1999). When the vote was passed for the first time, the Democrats and Republicans could not agree as a new law that included the clients medical and financial privacy was needed.

The House and the Senate presented their versions and the Democrats agreed to back the bill on condition that the Republicans would allow the Community Reinvestment Act to be restructured and ensure that the privacy issues were addressed. After the agreement, the bill came to pass as voted by the majority in both the Senate and the House and became law when signed by the then President Bill Clinton in 1999. The dissolution of the Glass-Steagall Act saw banks such as Citigroup engage in the trading of mortgages in the security market as well as establishing various investment structures. Gramm-Leach-Bliley Act of 1999(GLBA)

This Act came into being as a modification of the Glass-Steagall Act. This act made it possible for the banks and insurance banks to work together. It also gave the states the authority to control insurance policies such that banks are allowed sell insurance just as the insurance companies themselves. In addition, banks were allowed to undertake commercial banking, invest and deal in real estates and other activities that are found within the law. According to the Gramm-Leach-Bliley Act, municipal bonds are now able to be traded under this law. The financial institutions are also not supposed to reveal their clients information to the public.

Individuals who break the law stand to be penalized in court for breaching this law (DeLong & Ramirez, 1996). This is good for the businesses that are protected by the law but it is bad for the general public who is not aware of the progress of certain businesses and if they have invested in the companies they risk losing a lot of money. This can be said to have contributed to the current financial crisis that is facing the country and has slowly trickled to the rest of the world. People were unaware that certain big companies were not doing very well until it was too late in the day when nothing could be done.

Several changes were made in the Reinvestment Act which restricted financial companies from being formed of they did not attain the required CRA standards as well as insurer their depository institutions against risk. Grants would be given to upcoming financial institutions if they showed progress in their ratings. This Act enhanced activities between the commercial companies and the depository institutions. In addition, the act eased some procedures for acquiring loans that were used by the Federal home Loan Bank system.

This therefore meant that more people can access loans which are used in productive ventures in the economy thus assisting in its growth. How the Gramm-Leach-Bliley Act of 1999 has changed financial firms’ business conduct, both financially and ethically The Act was a relief to the Banks as well as the insurance companies as it addressed some of the changes that they wanted. The act ensured that people were able to invest in the economy and save their returns as this will be helpful when the economy is doing badly like the current financial situation.

The Gramm-Leach-Bliley Act would enable business and people to undertake these activities in the same organization as the banks and investments were allowed to work together. This will therefore be helpful in any economic cycle (Cocheo, 2000). Before the act was enacted, it was illegal for the investments companies and banks to merge in accordance to the Glass-Seagall Act but under the new law, this was made possible such that companies such as Travelers and Citigroup merged and this merge is a success. This Act ensured that there were rules which were meant to be followed by everyone.

This was because some banks and investment organizations used to evade following some rules in the Glass-Steagall Act because back then banks were restricted from selling securities but some banks did. The Gramm-Leach-Bliley Act was to ensure that the financial business code of ethics took center stage and those who broke the law risked to be penalized. It is this fear of incurring extra legal expenses and destroying the companies image that has made the financial institutions more organized and coordinated so that they can provide better and improved services to their clients.

Big banks are becoming more accountable and transparent and this is increasing the trust in the banking industry by the public (Heakal, 2009). Improved business practices as enhanced by the law made the smaller financial institutions to come up. This is because they were supported by other organizations. Some retail banks also engaged in insurance brokerage as a means of increasing their profits. The Act therefore gave the banking industry a lot of business opportunities to develop themselves as well as provide employment for the masses.

The Act enhanced the growth of the industry by incorporating strategic business development plans into their operations. This was a positive influence for the banks as they knew in order to be successful, they have to invest in proper business plans which entail forecasting and analyzing business trends which is directed by results-driven leaders. Banks were therefore required to be keen in the types of businesses they engage themselves in so that they can avoid prompt business ideas that can lead to their demise as experienced in some banks.

To ensure that businesses are protected in the financial market, the Act was made in such a way that it does not allow the mergers of organizations that do not meet the CRA(Community Reinvestment Act) standards. “The GLBA also insisted on the rule that the financial institutions are not allowed to own non-financial organizations (Birritteri, 2001). ” Likewise, other non-banks institutions are not allowed to join the commercial banking industries. This ensures that there is continuity in all forms of business in the country as this will aid in the general improvement of the country.

The restrictions that are there are important as they govern the investment practices and baking in an organization so that the roles are not confused and that the various segments concentrate in offering the best services to their clients. The GLBA further addressed the Financial Privacy Rule and the Safeguards Rules which talks of issues of disclosure about their client’s information. In addition, they state what the financial institutions ought to do in order to comply with set standards The rules also apply to the organizations that engage in various business transactions with the organization.

The Financial Privacy Rule Financial institutions are supposed to give their clients notices which outline any information collected about the client and people who are aware about the information and how they use it. An agreement is signed between the client and the financial company such that the company will be held liable for any damages thereafter. The GLBA also safeguards customers from pretexting practices which occur when people will try to get non public information without being given permission (Santomero, 2001). This action is punishable by law if a person is found to have engaged in it.

The GLBA encourages the financial organizations use the safeguards rules as they develop plans for implementation. Educating and training the employees about the programs is also useful as they will develop methods of dealing with the problem. The GLBA defines financial institutions as well as their roles. They also define the consumers and the rights they have. This is important as it helps people and institutions to understand the roles they play in the financial industry and the ethics that govern their operations and relationship.

Banking institutions have developed through foreign expansion where they undertake underwriting, distribution and broking securities in countries for example Britain. But this is not possible for other foreign banks practicing their businesses in the country as they are restricted from doing so by the international Banking Act of 1978 (Santomero, 2001). This means that they are not free to trade with the country making it disadvantaged. This is why there is a need for reforms in such areas to allow the banking institutions to expand their businesses in such security areas.

The International banking Act made the foreign Banks conduct business in the USA in accordance to the GSA provisions. Conclusion The US bank regulatory system still needs a lot of reforms so that the mistakes that have been learnt from can be rectified through the formation of proper laws. With the existing financial situation, these regulatory procedures in the depository institutions and the investment banks will occur. Modernizing the various agencies and legal institutions is therefore a key factor of enabling change that is urgently needed.

The wall that was created between commercial and investment banking was formed to prevent a loss of deposits in case investment was negatively affected as a result of financial crisis. The reasons for the removal of the Glass-Steally Act and the establishment of the Gramm-Leach-Bliley Act show that control or limitations on depository institutions and investment banks attempts for safety purposes can have adverse effects on the economy. References Birritteri, A. (June 1 2001). Modernization Act Brings One-Stop Shopping For Financial Products.

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