Question

Why are banks restricted in the assets that they can own? for example, why do you think banks are prohibited from owning stock?

Answer 1

Banks are a very essential component of any economy. It provides an easy way for people to save money and make payments. Without these services the economy would come to a halt.

There is a restriction on what a Bank can hold, this is specially done so that the bank does not hold risky assets and then it becomes a problem to pay back the investors and the customers. Banks cannot own bonds that are below investment grade nor any bonds by a single issuer that is greater than 25% of the bank's capital. Likewise, a bank cannot have more than 25% of its capital in another bank.

Banks in many countries cannot own stock as they are very risky and based on the stock market prices and the financial state of the company issuing the stocks that may change at any time, if the stock market’s collapse the Banks will ultimately collapse as well.

However there is an irony here as banks cannot own stocks but can own derivatives which is even more riskier than stock. Banks ownership of stocks was forbidden by the Banking Act of 1933 due to the stock market crash, this was much before the Derivatives market even existed. There was a major crises due to derivatives and mortgage backed securities in 2008-2009.

Banks also use high leverage that poses a moral hazard on the banks capital and the investments from the general public.

Thus after all these crises there has been a greater supervision on the banks and the activities that they can conduct. Banks are required to adhere to all the norms and regulations laid down by the Federal Reserve banks and also issue their financial reports to the investors so that they can as well access the financial health of the bank. Banks also have to maintain the reserve requirements with the Federal Reserve to maintain a cushion against the losses if any that the bank would suffer.