Recently, Sens. Elizabeth Warren, D-Mass., Maria Cantwell, D-Wash., and John McCain, R-Ariz., introduced legislation in Congress to limit the type of activities that commercial banks should be allowed to engage in over and above the traditional deposit gathering to limit risky exposure to FDIC insured deposits.
While it is tempting to revive the moribund 1933 Glass-Steagall act repealed by Congress in 1999, it is a bad idea. The old act attempted to erect what was then commonly known as a Chinese wall between Federal Deposit Insurance Corp.-insured deposits and more risky investment banking products like swaps, IPO underwriting, hedge funds and derivatives. The problem is that the train has already left the station.
Now, anyone with a modicum of financial common sense realizes that it is extremely important to preserve and protect the financial system from a free fall due to unbridled risk-taking. The problem is that technological advances have tremendously weakened regulatory oversight.
I am always amused whenever I hear the term "too big to fail" when, indeed, what we know today as major banks are in actuality an amalgamation of failed financial institutions. The history of modern banking is replete with spectacular failures.
Banks provide a unique service to the economic system by money creation, a term commonly used to allude to the multiplier effect of lending from the Federal Reserve's monetary policies and bond activities through the banking system. For the economy to prosper, the banking system has to be healthy.
For instance, there have been questions raised whether the FDIC is charging the banks a sufficient premium commensurate with the banks' risk profiles. But any increase in insurance premiums will be passed on to the deposit and borrowing public. So obviously there is no cheaper funding source than short-term and demand deposit/savings accounts. The challenge is in insuring that the banks are not remiss in their fiduciary responsibilities by turning around and lending these funds long term.
Hedge funds are set up for investors considered sophisticated enough to understand their levels of risk exposure and accordingly have no recourse in case they suffer losses as a result of the investment decisions made by fund managers.
By the same token, hedge fund managers have been able to attract institutional investors including nonprofit, endowment and even pension funds to benefit from the higher yielding albeit riskier hedge fund portfolios.
Aside from the risk-return trade-offs, the salient question is delineating the role of a depositor from that of an investor. When you make a deposit at a local bank, there is an expectation of duty that you can make a withdrawal upon demand without any chance of loss.
An understanding of this dichotomy will alleviate the difficulties facing the role of banking because as the recent financial meltdown has demonstrated, there are no guarantees of return whether the banks are making loans to fund plain vanilla home loans or investing in "hot" emerging markets hedge funds.
In light of the alarming speed in technological advances, it has become increasingly difficult even to arrive at a consensus on the definition of money and banks are still owned by stockholders who hold bank management accountable for profitability and performance. The last time I checked, the bank is still where the money is.
Iffy Okechukwu is president of Opus Business Dynamics, an Oakland-based banking and international consulting company.