The Financial Services Modernization Act is a law that was enacted in the United States in November 1999. This law signed by President Bill Clinton is a deregulation law in the financial industry sector, where in this law, essentially the banking, insurance, and securities may affiliate with and market each other’s financial products. So, since this law was passed, there is no longer a barrier between investment banks and commercial banks, and every entity in the financial industry can do business with each other.
Looking at the Financial Services Modernization Act, it cannot be separated from the Glass-Steagall Act of 1933. In the Glass-Steagall Act, it is clear that there are different separations and regulations for investment banks and commercial banks. This is nothing but done to minimize the misuse of customer funds by the bank to be allocated to risky businesses and instruments. In essence, the Glass-Steagall Act is carried out to protect the interests of customers. But the negative impact of the Glass-Steagall Act is the development of the financial industry which is felt to be stagnant.
Therefore, in order to increase the resilience of the financial industry, since the 1980s there has been a discourse to abolish the classification of investment banks and commercial banks. Every bank and other financial industry entity is considered to be given the freedom to do business in order to increase the value of the financial industry, as well as to expand public opportunities to enjoy various financial products. So, in 1999, changes were made to the rules in the Glass-Steagall Act and every bank and financial industry entity was freed to carry on its business in creating, selling, and affiliated with each other in financial products.
Since the enactment of the Financial Services Modernization Act, the financial industry in the United States has grown rapidly. Many new loans were disbursed, and at the same time many derivative products were traded between institutions. But this has actually become a boomerang because in the end this is what caused America to experience the subprime mortgage crisis and caused a global crisis in 2007. Yes, the freedom of every bank to form a holding company makes banks tempted to profit from the sale of derivative products, and one of them is derivative products. based on credit. However, because there was too little credit available, credit was disbursed to subprime groups, or customers who were not eligible for credit. In the end, bad loans occurred on a large scale and resulted in the destruction of the financial industry at that time.
In fact, this is what America’s top brass feared would happen in 1933, and it’s the reason they enacted the Glass-Steagall Act. But the greed of capitalists, especially bankers, is more concerned with their interests than long-term monetary stability. Tempted by the huge profits, they even urged the government to pass the Financial Services Modernization Act. A decision that was regretted by the American government itself in the end.
In the end, the Financial Services Modernization Act was declared null and void in 2010, and the Glass-Steagall Act was reinstated through the Dodd-Frank Wall Street Reform and Consumer Protection Act which was enacted in the same year.
The Financial Services Modernization Act was passed in 1999. It was initiated by a three-person Senate consisting of Phil Gramm, Jim Leach, and Thomas J. Bliley, Jr. This is why the Financial Services Modernization Act is sometimes referred to as the Gramm–Leach–Bliley Act (GLBA).
The Financial Services Modernization Act is a milestone in the deregulation of banking in the United States. Where various strict rules that exist in the Glass Steagall Act are removed. For the uninitiated, the Glass Steagall Act was the first law in the US to separate investment banks and commercial banks from using customer funds for investment in the stock exchange and instruct commercial banks to invest in relatively safe government bonds.
Many banks, brokers, and insurance companies objected to this law and lobbied the US parliament to change a number of rules and the Financial Services Modernization Act was born. What rules are changed in this new rule? Here’s the list:
– The separation of investment banks and commercial banks was abolished with the creation of new entities called financial holding companies (FHC). FHC can offer a wide variety of financial and insurance products that were previously not allowed.
– Assets of FHC subsidiaries are limited to a maximum of 45 percent of the total assets of the parent or the equivalent of 50 billion USD.
– Require banks to notify customers of customer personal information that will be shared with bank subsidiaries. The customer can refuse or agree to the sharing of this information.
– Provide supervisory authority to the Fed which provides the ability to regulate the financial sector and oversee specific financial activities.
However, there are also a number of rules in the Glass Steagall Act that have not been changed, such as:
– Merger can be done when two companies pass the Community Reinvestment Act (CRA) qualification.
– Financial companies are prohibited from having subsidiaries in the non-financial sector. Likewise, non-financial companies are prohibited from having subsidiaries in the financial sector.
– Maintaining the separation of investment banks from commercial banks under one group. This is done by requiring employees of each bank to use a special identity that states they work in a division or subsidiary of an investment bank or commercial bank.
– Require banks to protect customer information.
The negative impact of the Financial Services Modernization Act
The Financial Services Modernization Act was the root cause of the 2008 financial crisis. The reason is that FHC opens the potential for commercial banks and insurance companies to access risky assets such as subprime mortgages. As a result, when the bubble burst and the financial crisis occurred, the financial sector was the first to be hit.
Key principles of the Financial Services Modernization Act
The main principles of this Law are to promote competition, innovation and efficiency in the financial system while protecting consumers. This law allows banks, securities companies and insurance companies to compete in their respective markets, which is intended to promote innovation and competition. The law also requires financial companies to meet certain safety and health standards, which are intended to protect consumers.
Broadly speaking, this law is divided into two parts: the first part deals with banking, and the second part deals with securities. Let’s take a closer look at each of these sections.
In the first part of the Financial Services Modernization Act, banks were allowed to carry out mergers and consolidations, effectively creating larger banks that were better able to compete in the market. It also allows banks to offer a wider range of products and services to their customers.