Question

During the 1999’s The Financia Services Modernization Act of 1999 was enacted. What did this law do? What were some of the consequences for the US banking system?

Answer 1

Financial services modernization act of 1999:

A law to partially deregulate the financial industry. It allows the companies working in the financial sector to integrate their operations and invest in each other’s business and consolidate. This includes businesses such as insurance companies, brokerage firms, investment dealers, commercial banks etc. also known as Gramm-Leach-Bililey act.

Impact of act on US banking:

Before the act, there were three types of banks namely bank holding companies, bank holding companies with section 20 subsidiaries and investment banks. After the act, there are five types of banks namely bank holding companies which don’t expand their business to investment banking activities, bank holding companies which expand their business to investment banking activities, bank holding companies with section 20 subsidiaries before 1999 and do not transfer into FHC after 1999, bank holding companies with section 20 subsidiaries after 1999 and transfer into FHC after 1999 and investment banks.

Banks which had section 20 subsidiaries before 1999 became financial holding companies after 1999, exhibit increased risk and are more volatile than any other banks. Banks which didn’t have section 20 subsidiaries before 1999 and become financial holding companies experience less risk increase and there is evidence that they benefit from diversification.

To conclude 1999 act make some banks take more risk. But not all banks follow the same route. When market is good risky banks behave better than less risky banks. However when market is bad, risky banks behave worst than less risky banks