Volcker backs much needed banking system reforms

Yet another of the financial world's exemplars has come out in favor of a two-tier banking system in the United States.

Former U.S. Federal Reserve Chairman Paul Volcker said commercial banks should be separated from investment banks to avoid another crisis like the one the United States and the world is currently grappling with, Bloomberg News reported Friday.

Let risky banks pay for their risk

"Maybe we ought to have a kind of two-tier financial system," said Volcker, who also heads President Obama's Economic Recovery Advisory Board, Bloomberg News reported.

Volcker said commercial banks would provide customers with depository services and access to credit and would be highly regulated, while securities firms would have the freedom to take on more risk and practice trading, "relatively free of regulation," Bloomberg News reported.

Comment: As readers of this space are aware, two-tier banking, discussed several months ago by my colleague economist Richard Felson, has long been favored here.

Briefly, Felson argues that there should be two levels of banks. The first level: private banks that invest in higher-profit operations, offer higher interest rates and have other exotic investment products, but offer no government insurance on deposits.

The second level: community-based banks that invest primarily in conventional mortgages and other standard products, offer very low interest rates on deposits, have no high-risk / high interest rate investments, but offer government insurance for depositors.

The Obama administration is expected within weeks to announce legislative proposals for banking regulatory changes and financial service reforms.

Banking Sector Analysis: Felson's proposal, and the one that I favor, would place strict, low ceilings for bank executive, professional administrative and loan officer salaries. It's not likely that Volcker's recommendations, or the Obama administration's proposals, will include compensation caps that are low (under $500,000 per employee). That said, Volcker's support for the overall two-tier concept is a pleasure to see, as it brings us closer to a democratic, financially sound, responsible, and ethical banking system.

We want banks to take deposits, lend, process transactions, create wealth, and perform a myriad of other functions that have helped economies grow for hundreds of years -- and that's what the two-tier system seeks. What we don't want is bank losses and recklessness paid for by the U.S. taxpayer.
Read Full Story

From Our Partners