This restriction contrasts with more liberal banking regulations in other countries and also with the prescriptions of traditional financial theory, which says that a firm’s lender would make better decisions if it also held some equity in borrowing firms.1 According to this theory a bank that holds an equity share in firms to which it lends would strike a more sensible balance between caution and risk-taking and would also be more concerned about its borrower’s long-term financial health. The Gramm-Leach-Bliley Act of 1999 modestly expands bank powers to hold equity in nonfinancial firms, but it stops well short of permitting banks to hold mixed debt-equity claims as a normal lending practice, as would be permitted, for example, in Great Britain or Germany.

This article appeared in the May/June 2000 edition of Business Review.

  1. See the article by James Barth, Daniel Nolle, and Tara Rice for a comparison of international restrictions on bank equity holdings and Christopher James’s 1995 article for a discussion of U.S. laws governing bank equity holdings in distressed firms. Loretta Mester’s article provides a general overview of the issues involved in the separation of banking and commerce.
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