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Most of the investment banks in existence today have been around for several decades. For much of this time, the investment banking industry has been a haven for unprecedented growth. The industry has seen many risky practices to evolve periodically. This is why the investment banking industry has often been under the scrutiny of the different types of regulators.
It is common for investment bankers to be blamed after almost every major financial crisis. It happened in 1933, and it also happened in 2008! It is common for regulations to be changed several times to keep pace with the change in the investment banking industry. However, over time, some legislations have become landmarks in the industry. These regulations and laws are known to almost every investment banker in the world. In this article, let’s have a closer look at some of these laws:
The Glass Steagall Act is perhaps the most important piece of legislation in the history of investment banking. It came into effect in the year 1933 after American stock markets had crashed in the year 1929. The main provision of the Glass Steagall Act was the separation of concerns. This meant that commercial banks and investment banks had to be separated from each other. This is because it was believed that the crash of 1929 was caused due to the excessive money pumped in by commercial banks, and the money used belonged to the depositors.
Prior to the Glass Steagall Act, it was common for commercial banks to make unsound loans to certain companies. These loans were then supplemented by the share purchase of those same companies by the investment banking wing of the banks. The main idea behind the Glass Steagall Act was to ensure that the funds raised by the banks are used for lending rather than for speculative purposes. This act continued to be in place for almost 70 years until 1999. It was then repealed by another act. However, it would be fair to say that the investment banking industry has been deeply shaped by the Glass Steagall Act.
The Securities and Exchange Commission was created in 1934. This was done with the intention of overseeing the activity of various market participants in the primary market as well as the secondary market. Intermediaries like investment banks are supposed to register with the Securities and Exchange Commission. Also, since investment banks are major players in the securities market, their activities are scrutinized by the Securities and Exchange Commission until today. Over the years, the Securities and Exchange Commission has come to regulate each and every aspect of the investment banking operation. This includes licensing, accounting, product offerings, etc.
The Investment Advisors Act was created in 1940 with a view to protecting the interest of the investors. Prior to 1940, many investment companies were deliberately giving wrong advice to investors in an attempt to defraud the investors. In the 1940s, all investment companies which were giving advice to clients were required to register themselves. Also, they were supposed to follow certain regulations that were set forth by the regulatory bodies failing, which they were subject to fines and penalties. This act had an impact on investment banks also as they were also supposed to comply with these norms. This act provided limits on the fees and commissions that could be collected by investment advisors for the services provided by them.
Another act called the Securities Investment Protection Act was created in 1975. This act provided a type of insurance for the clients of brokers. Hence, if a broker went bankrupt, the liabilities of the broker would be covered by this act up to a certain extent. This act also impacted investment banks since they are involved in prime brokerage operations and also extensively deal with other brokers.
The Gramm-Leach-Biley Act, commonly known as GLBA, was passed in 1999. It is commonly known to be a repeal of the Glass-Steagall Act. In the 1990s, financial institutions in the United States started claiming that regulations were preventing them from growing and diversifying their risks. Hence, in order to enable the growth of the financial institutions, the earlier restrictions were repealed. Right now, it is possible for commercial banks in the United States to also have an investment banking division.
The Basel 3 requirements were brought into place after the 2008 collapse. The Basel 3 requirements worked on the assumption that the crisis happened because banks were recklessly issuing fixed income securities. Hence, they increased the amount of capital that has to be kept in reserve when fixed income securities are issued. This made it more expensive for banks to issue these securities. Since the distribution of these securities formed a major portion of the income earned by investment banks, their income has also been affected by the Basel 3 regulations.
The Volcker rule is an important part of the investment banking regulation in the United States. It has been created in 2010 after the subprime mortgage crisis. As per the Volcker rule, investment banks can no longer pitch risky investment to commercial banks and other institutions which receive insurance protection. Since banks were one of the biggest buyers of these financial instruments, this has created problems for the investment banking community.
The bottom line is that all the operations in the investment banking industry are heavily regulated. This can be seen from the extensive history of these regulations, which have been listed above.
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