Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Banking and Commerce: Tear Down This Wall?

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Banking and Commerce: Tear Down This Wall?

Article excerpt

Many U.S. firms include both commercial and nonbank financial units. For example, General Motors Corporation encompasses not only units that manufacture automobiles but also those, such as General Motors Acceptance Corporation, that gather funding and make loans to individuals and businesses. Firms that handle both commercial and financial activities appear to reap significant benefits that create the appeal of such combinations. One byproduct of a commercial firm's activities may be information about its customers' financial situation. The financial affiliate might then use this information to inexpensively target products to particular customers, benefiting both the financial firm and its customers.

While finance/commerce combinations are widespread, combinations between banks and commercial firms are typically prohibited under various U.S. laws. Banks are distinguished from other financial firms by their ability to gather funding by issuing government-insured deposits such as checking and savings deposits. Despite prohibitions of banking/commerce combinations, firms have managed to find loopholes. Until recently the unitary thrift loophole was a popular means of circumventing the banking/commerce wall. The loophole allowed commercial companies to start or buy one, and only one, thrift (i.e., a savings bank or savings and loan association, both of which issue government-insured deposits), using the thrift as a conduit for providing financial services.

The unitary thrift loophole was closed in 1999, but another loophole remains open. Federal banking law allows commercial firms to own industrial loan corporations-essentially banks with somewhat restricted deposit-taking powers. (For additional discussion of the unitary thrift and industrial loan corporation loopholes, see the Appendix.)

Given the apparent benefits of combinations, why prohibit or restrict them? What hazards result from banking/commerce combinations? Traditionally, discussions of the threats focused on conflicts of interest and diminished competition. More recently, observers have been concerned that combinations might increase deposit insurance claims and expand the universe of economic activities protected by the government safety net. As will be discussed presently, the traditional concerns seem less relevant given the level of competition banks face in today's banking market. Over the last twenty-five years, competition has expanded as restrictions were eliminated on banks' ability to operate across state lines and to offer market rates on deposits. Also, new nonbank firms have arisen offering financial products competitive with most banking products. The concerns over increased deposit insurance claims and expansion of the safety net remain quite relevant. Nevertheless, over the last decade a number of legislators have argued for removal of the banking/commerce wall. I will analyze the threats and suggest some restrictions that would be necessary if the wall were removed.


The building blocks of the wall between banking and commerce are various federal and state laws. The laws prevent banks from engaging in commercial activities. They also prevent banks from owning subsidiary commercial companies and from being owned by companies conducting commercial activities. Specifically, the building blocks are the National Bank Act of 1864, state banking laws, the Federal Deposit Insurance Corporation Improvement Act of 1991, and the Bank Holding Company Act of 1956. (For a detailed review of these statutes and their motivations see the Appendix.)

The National Bank Act limits the powers of national banks and their subsidiaries. National banks are those chartered and regulated by the U.S. Treasury Department's Office of the Comptroller of the Currency. The Act states that "a national banking association shall. . . have power to. . . exercise. . . all such incidental powers as shall be necessary to carry on the business of banking" (12 U. …

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