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Glass-Steagall Act 2.0: Ripple Effects?

Proshare

Tuesday, July 04, 2017 6:25 PM /FDC 

In a bid to maintain his rhetoric as ‘a man for the masses’, US President Trump intends to introduce banking legislation to sepa-rate the big banks and reduce excessive risk taking. The legislation referred to as the Glass-Steagall Act (GSA) 2.0 echoes the repealed GSA of 1933. 

Its repeal in 1999 is widely blamed for causing the global crisis of 2008/2009 that affected countries of the world, Nigeria inclusive. Critics of the 1999 repeal, most notably Nobel Laureate Joseph Stiglitz, argued that the removal of the GSA introduced the culture of excessive risk taking to a point where the risk-return balance of bank loans became fundamentally flawed. 

Given the strong criticism of the repeal it would be fair to assume that its re-enactment could have positive effects on the American economy, and the global economy as a whole. 

However, the political undertones of this move, as well as the ongoing ambiguity of how and when the act will be reinstated, might undermine the impact of this policy shift on the US and global market, if implemented. 

On the Nigerian front, while the positive effects are ambiguous at best, the negative effects could be quite damaging. The break-up of the big banks could halt the velocity of lending into the country, which is likely to reflect through shocks to sectors such as the manufacturing sector. 

As leverage is a focal part of many business institutions, these institutions have to explore alternative sources of foreign debt. 

The Glass-Steagall Act of 1933 was a reaction to the waning confidence in the banking system following the great depression. 

At the heart of one of the most turbulent years in US history, the banking system had nearly crashed with many banks in the then 48 states either completely closed or with restrictions on deposit withdrawals. 

The Act established the Federal Deposit Insurance Corporation (FDIC), alongside a set of rules that prohibited the synchronized activities of commercial banks and investment banks. 

This effectively separated high-risk speculative investment activities associated with investment banking from fairly-low risk activities associated with commercial banks. 

In the years leading up to the 1999 repeal of the GSA, the legislation had been open to subjective regulatory interpretations, which benefited certain stakeholders. 

In other words, business friendly practices, and not necessarily market friendly practices, were possible depending on the interpretation of the legislation. By 1999, the GSA was replaced with the Gramm-Leach-Bliley Act (GLBA). 

The GLBA lifted all barriers that prevented commercial banks, in-vestment banks and insurance establishments from consolidating and as such any one enterprise could offer the services of all. 

With this change, the dominant high-risk high-return investment banks took prominence. Hence Stiglitz’s conclusion about introducing a culture of excessive risk taking. 

With President Trump’s interest in the defunct GSA, the Congress, Senate and other stakeholders are submitting proposals. For ex-ample, the vice chairman of the FDIC proposed a requirement that big banks refurbish their internal structures, which in turn makes them less susceptible to high-level risk.

While this renewed interest in increased regulation is welcomed, many are skeptical about the political undertones for the policy shift. There is also concern about the impact such legislation would have on the big banks. 

Banks such as JP Morgan Chase, Morgan Stanley, and Citigroup etc would be at risk of a break up. Some believe this would incapacitate these banks from cushioning other banks upon failure. 

Bank of America (BoA) head, Brian Moynihan gives the example of the BoA rescuing Merrill Lynch during the 2008 financial crisis. He argues that it was much better to have the failing brokerage form a part of the group, as it allowed for economies of scale and scope which facilitated stronger businesses, and in turn better, more stable and more secure products for the consumers. 

However, others argue that in terms of a typical bank customer, a split up of banks would have absolutely no effect on utility. This is because the average customer will have access to the same kind of financial products as he is used to. 

There might just be a shift in the financial service provider. Downsizing would only encourage banks to resort to their functions from the not so distant past. 

Impact on the Nigerian Economy 
From a Nigeria-specific perspective the negative impact likely out-weighs the positive. Increased regulation is welcome in so much as it contributes to a more stable global financial system. 

However, a possible disruption to lending from the big American banks to the Nigerian economy does pose a threat. With more stringent rules and regulations the banks will be forced to re-evaluate their business models and reduce exposure to high-risk investments. 

Currently given the political and socio-economic profile of Nigeria, lending towards the region might be capped, or stopped altogether in the worst-case scenario. This is likely to have an impact on sectors such as manufacturing, agriculture, and trading which have a high number of firms that leverage foreign debt. 

For those that leverage American loans, a proactive search for alternative funding sources of foreign debt may be in order. 

On a more positive note, the country stands to benefit indirectly from what is perceived as a more transparent financial market. 

As has been discussed, many are of the opinion that the repeal of the Glass-Steagall Act in 1999 directly or indirectly caused the financial crisis. 

Since then, by means of legal and ethical standards set in place, confidence has relatively been reinstated in the market. It is believed the switch back to the GSA will push the financial market further towards the euphoria that is a perfect market, mitigating exposure to shocks. 

For a country like Nigeria, which only narrowly avoided the last financial crisis, it is one less challenge to worry about. 

As many speculate on whether or not the GSA 2.0 will in fact take shape, the possibility of its reinstatement will likely influence the Nigerian financial market. 

This is because of how integrated the world has become (minus the recent anti-globalization rhetoric that has thankfully begun to dissipate). 

As such, the Nigerian market will have to evolve with this trend to be remotely attractive to investors. 

The exact timing when the GSA 2.0 will be presented before congress remains unknown and the jury is still out on whether or not it is to have a significant impact in the US market and beyond.

The one thing that remains true is that the global market can still benefit from increased transparency in the financial market and that it is likely to have a ripple effect on advanced and emerging markets alike, such as Nigeria.  

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