Written by:
Sandeep Gautam

The Future of U.S. banks after the financial crisis

Banks in the U.S. witnessed everything in the last couple of years – regulation failures, massive government intervention, bailouts, and the talks about limiting their size and scope. But what are the consequences of these financial developments? What does the future of U.S. banks look like after the financial crisis?

Let’s start with the famous Volcker Rule, proposed by former Federal Reserve Chairman Paul Volcker and publicly endorsed by President Obama. The Volcker Rule, which has not been implemented yet, proposes ban on proprietary trading – trading on bank’s own behalf rather than on behalf of its clients so as to make profit for itself. This rule also bans big banks from investing in hedge funds and private equity activities. While highly controversial and opposed by many bankers, this rule is good for the financial system, because it makes banks focus on what they are supposed to do and what they do the best: serving customers and clients.

In current situation, banks are taking risks on their behalf and on behalf of their customers as well. If the risky activities fail, taxpayers’ money is being used to support the system and keep banks afloat amid the fiasco. One major implication of this act of the federal regulator is that banks might continue to take on risky business like mortgage-backed security risk, especially now that they know the fed will rescue them in times of breakdown. So how to prevent banks from doing so in the future? Raghuram Rajan, the University of Chicago economist, says, “What you (the federal regulator) really want to do is prevent bank runs when it is truly a systemic panic, but not when it’s because of the fault of the bank itself.”

It looks like the scope of banks will be limited in the future, and ideally banks will be held accountable for their risky behaviors rather than the fed just bailing them out which encourages banks to continue taking risks. But making banks completely risk-free is implausible. Banks will find their ways, possibly by shifting their risky businesses to offshore locations like Hong Kong and Singapore.

Photo courtesy of Flickr.