Monetary Policy and Financial Institutions in Financial Crisis

Solution Preview

Hello, please take a look at the following.

Effect of Glass-Steagall Act over Banks

Before the introduction of this act, banks were free to use depositors' money in any form. Banks at that time were too speculative and were taking highly risky decisions in the hope of getting maximum returns. The objectives of banking have changed to earn maximum profit with people's money. Banks were providing unsound loans to such companies in which banks have their interest. The American banking industry was getting worse with the steps taken by the banks. Over 11,000 banks have been closed and there has been decline of almost 40% in the number of banks in the country (Markham, 2006). The introduction of this act has resulted into both positive as well negative impacts over banks. It has helped banks to improve their financial condition through making better investment decisions.

Through this act, banks are allowed to make limitations into their services, like either commercial banking or investment banking. Banks were able to focus more on a single part of their business. Sound investment decisions are being taken from the banks' side, resulting into profit maximization of banks. The risk factors associated with banks have reduced to a great extent, which has increased the number of customers. Since there was too much transparency into the system, there were very limited chances of risks to arise (Geisst, 2004). Apart from this, it has also helped banks to formulate effective strategies to explore the limited resources. With this act, banks were prepared with the challenging environment in banking industry. Competitive innovation in banks' working environment is the result of this act.

Yet, at the same time, many believe that with the introduction of this act, it has become very difficult for banks to maintain their financial stability. Since the doors of opportunities have closed for banks, the market share of banking industry was rapidly declining with the increase of market share of security firms (Hassan & Lai, 2005). The investment in security firms was very high in comparison to banks, so there was loss of profit margin for banks. In addition to this, banks were unable to provide customers with a wide variety of products that further affected their business. As there were many customers, who wanted all kinds of financial services under same roof, banks were unable to explore benefits from such customers.

At the same time, it has subsequently affected the banks' customer base also because of business diversification. There, more conflicts of interest arose between banks that made the banking industry more competitive. It has become difficult for banks to survive ...