In the developed world, banks have recovered faster than the other sectors of the economy, and now face concerted regulatory action in many countries. After they were bailed out with enormous amounts of public money, it was expected that they would be more circumspect and avoid the practices that landed them and the global economy in a grave crisis. Instead, their imprudent investment banking activities have continued unabated. High investment fees boosted their profitability and made some of them declare oversized bonuses, which in turn triggered public anger against the banks. Government intervention in the financial sector has not waned even after the gradual withdrawal of the massive support that ironically contributed to the soaring profits. In all the developed countries, there is a strong public opinion in favour of reining in the banks. The United States and the United Kingdom have imposed an additional tax on bankers’ bonuses. Sweden has instituted a “stability levy” to curb risk-taking. But the plan unveiled by President Obama last week goes farther than any proposal mooted so far by other countries or in the G20 summits.
One part of the plan seeks to restrict the scope of banks’ activities. Banks that have insured deposits, and thus access to emergency funds from the Federal Reserve, would not be allowed to own or invest in private equity or hedge funds. Nor would they be allowed to engage in proprietary trading, the practice of wagering their own money in the markets. The second part of the plan seeks to restrict the size of banks through a cap on their liabilities. The aim is to prevent concentration, which has actually increased during the crisis. In the future, American taxpayers would not be held hostage by a bank that is “too big to fail.” The new plan has many features in common with the Glass-Steagall Act enacted in the aftermath of the Great Depression, but it does not envisage segregating commercial and investment banking activities into water-tight compartments. However, many of the mighty banks that transformed themselves during the crisis have to readjust by shedding proprietary trading and abandoning hedge fund activities, for instance. The plan might be difficult to enforce but that cannot be an argument for shelving or even diluting what appears to be the boldest attempt till date to bring big finance in line with the public interest. In this, there are lessons also for India, which has fortunately kept commercial banking and investment banking activities separate. It is about time that the strictly non-bank activities, such as those relating to the capital market and credit cards, are evaluated in terms of risks and returns.