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Banking Law: Diversification in the Commercial Banking Industry


The Financial Services Modernization Act of 1999 (also known as the Gramm-Leach-Bliley Act) has considerably changed the landscape of banking and commerce in the United States. In the past, when clients wanted to open a savings account, one could recommend a particular bank. When they wanted to purchase insurance or stocks, one would send them to an insurance company or brokerage firm, respectively. However, with the passage of this Act, the past has become prologue, and some very interesting twists and turns lie ahead for the banking and commerce industries. For this reason, it is important to seek an attorney experienced in the areas of banking and commerce regulation when deciding how to proceed in financial matters.

Diversification in the Commercial Banking Industry

The issue of diversification in the banking industry first became a problem in the early part of the 20th century. During the tumultuous financial crisis that began in the late 1920's and continued into the 1930's, American policymakers faced an especially difficult situation. Congress was eager to protect the public from further trauma in the wake of the Great Depression, which had caused a total collapse of the United States banking system. In response to the crisis, Congress enacted the Banking Act of 1933 (also called the Glass-Steagall Act), which separated commercial banking from investment banking in order to help ensure safer banking practices. They believed they could prevent financial instability simply by keeping brokerage and banking activities separate. Congress later passed additional laws in an attempt to protect the public from the perceived harm of "cross-fertilization" between the banking and commerce industry.

Chief among these new laws was the Bank Holding Company Act of 1956. The Act gave the Federal Reserve Board power to determine what businesses were permitted to be nonbank affiliates of banking institutions. However, even then, not everyone supported this forced separation of banking, commerce and insurance. Thus, for more than 20 years, banks and other industries engaged in a concerted effort to repeal laws that restricted a banking institution's ability to venture into other types of commercial transactions. Proponents of finance and commerce diversification hoped to replace these laws with regulation that allowed banks more easily to affiliate with insurance companies and securities firms. These proponents called such diversification "legal reform." The law's opponents questioned the soundness of any decision that would leave these institutions with few regulatory boundaries.

The issue was settled on November 4, 1999, when Congress passed the Financial Services Modernization Act. President Clinton signed the bill into law on November 12, 1999. Here is a brief summary of the major features of the Act.

The Act allows the formation of financial holding companies that may own banks, insurance companies and securities firms and engage in activities that are financial in nature.

The Act provides for functional regulation based on the type of financial activity rather than the type of entity engaged in the activity. That is, securities activities are regulated by the Securities Exchange Commission, banking activities are regulated by the appropriate federal and state banking agencies, and insurance activities are regulated by the states (pursuant to the McCarran-Ferguson Act).

The Act allows affiliation between banks and entities engaged in securities activities.

The Act requires financial institutions to provide customers with a privacy policy and give customers the opportunity to opt out of the sharing of nonpublic personal information with nonaffiliated third parties.


The Financial Services Modernization Act, indeed, has created another "wrinkle" in the tapestry of the financial world. Industry lawyers also have to "diversify" their skills in order to stay abreast of all issues faced by their clients. An experienced banking attorney now should also be proficient in legal issues faced by the insurance and securities industries.

In sum, passage of the Financial Services Modernization Act released the regulatory restrictions that formerly kept the American banking and commerce industries separate. Safeguards have been put in place to assure that this expansion is beneficial to the American public. To play an effective part on this expanding playing field, banks should seek the guidance of attorneys who are diversified in their commercial and banking law skills.

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