Question

Using an example, explain why a commercial bank is more highly regulated as compared to an investment bank.

Answer 1

Commercial Bank: It is a financial institution that accepts deposits, grants loans, offers checking services, and deals with basic financial products e.g. certificates of deposit (CDs), and also provides savings accounts facilities to individuals and small businesses.

Investment Bank: It refers to the division of a bank that is related to the creation of wealth or capital for government, business, and other entities. They also manage the financial aspects of large projects. It gives the facility of purchasing and selling of bonds, stocks, and other investments, and helps companies in initial public offerings (IPOs) when they first go public and sell shares.

A commercial bank is more highly regulated as compared to an investment bank because;

Commercial banks are highly regulated by federal authorities such as the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). They provide a certain level of security and also protect customer accounts. They give us a lower level of risk. They have an implicit duty to act for clients' benefit. Their level of risk decreases because of higher levels of government control.

They are regulated because they generally deal with the public and to protect the public they need to be highly regulated to win the trust of the general public. Their failures will create doubt in the saver's mind regarding the stability and solvency of commercial banks and cause panic in the general public. No regulation of commercial banks may deteriorate the bank's performance and may destroy household savings. Regulations are beneficial to households, firms, and the overall economy.

whereas,

Investment banks are loosely regulated by the Securities and Exchange Commission (SEC). It offers less protection to customers and allows investment banks a significant amount of operational freedom. It gives investment banks a higher tolerance and exposure to risk.

Example: Suppose you've deposited your saving to commercial bank in the view of interest but these banks loosely regulated and they didn't give you an extra interest on your savings. Would you trust the bank again? No, it will create a panic among general public.