Universal Banks, Universal Crises? Disentangling Myths from Realities in Quest of a New Regulatory and Supervisory Landscape

Abstract

The recent financial turmoil has instigated intense debate on the relationship between universal banking and financial stability. Employing legal and financial analysis and drawing on available empirical evidence, this paper critically analyses the arguments for and against universal banking, concluding that it resembles a double-edged knife: it presents opportunities but also bears risks. In this context, a case is made against the complete separation of banking and investment and in favour of a more fine-tuned regulatory regime. The paper suggests that, first and foremost, policy makers need to curb the systemic and systematic risk of large universal banks. From this perspective, the paper suggests that, alongside proportionate regulatory intervention for universal banks constituting systemically important institutions (ie stricter capital, liquidity and risk management requirements, adoption of a special resolution regime and a prompt corrective action procedure), enhancing supervisory effectiveness and market transparency should be top priority in the reform agenda.