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and relatively save. However in the past two decades financial deregulation and the widespread
use of securitization created “complete markets” for all bank products. Bank business models
have changed to exploit opportunities for fees and for regulatory and tax arbitrage. This shift
from “traditional banking” to a form of ”capital market banking” became associated with high
leverage and the composition of mark-to-market products with commercial banking assets and
liabilities.
Another key advantage of separation is reducing distorting incentives. With full separation,
deposit insurance would apply only to the retail bank and could not act as an implicit subsidy to
the investment banking, which would otherwise benefit from the formal (deposit guarantee
system) and informal (TBTF) guarantee. Both them formerly led to the underpricing of risk and
provided incentives to exceed its accepted level. This also rises a key policy question about
whether bank deposits should be used to fund speculative trading at all? Separated traditional
bank could go on lending to small and medium-sized enterprises regardless of how volatile
financial markets are. At the same time, separated investment bank would have to earn its
profits without any subsidy.
Arguing with separation proposals, banks often imply that it would raise the cost of doing
business. That is partially true. *Wancer, Dziekooski, 2011+. That is precisely what the policy
objective for higher-risk capital markets should aim to. Banks’ arguments ignore the cost the
current banking system has imposed on the “real economy” for last decade. Direct bail-outs,
increasing indebtedness of sovereigns, credit crunch – these are only a few examples of costs,
which were not displayed in banks’ balances *Zielioski 2015+. If for fair calculation, social cost of
banking operations would be taken into account, it is scarcely plausible that a reformed
banking sector could cost more. In fact, it might even get cheaper. Lending to the real economy
is likely to be considered less risky (also because of benefiting from a government guarantee of
deposits) and therefore be less costly than trading activities. Increased simplicity and
transparency on the operation of banks is likely to lower, not increase, funding costs.
Advocates of separation suggest also lower possibility of a systemic crisis, e.g. by reducing the
probability of contagion [Peach, 1941]. Opponents argue in turn, that activities of commercial
banks are also a source of risk. Separating it from investing activities therefore wouldn’t
eliminate the risk of losses [Blundell-Wignall, 2011+. They also argue, that regardless of bank’s
profile, its bankruptcy would undermine the confidence to other entities of the financial system
[Casserley, Härle, Macdonald]. Moreover, they pointed out, that historical experience does not
confirm unequivocally of the relationship between banking crises and the type of banks that
initiate it or which suffered the most severe the consequences [Wolf, 2014]. On the other hand,
advocates of the thesis answer, that due to restoring the concept of “incomplete markets”, the
interference between activities of investment and corporate banks could become limited.
Separation will decrease interconnection, as the separated commercial bank will mostly rely on
its deposit-base being therefore less exposed to market risk *Zielioski 2013+. Separation will also
decrease contagion possibilities, because most of the channels would be canceled and
firebreaks set between commercial and investment banking activities in the same group.
How should it be separated?
It will go a long way to preventing moral hazard and a funding subsidy for non-guaranteed
activities of investment banks. Anyway, both types of banks should be separated prior to a
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