The Costs of Banks Engaging in Non-Banking Activities: A Case Study

The century-long separation of banking and commerce enshrined in U.S. law has weakened in recent decades. The academic literature has thus far focused mainly on conceptual benefits and costs of the trend, arguing that the integration of banking and commerce might lead to efficiency gains through diversification in a greater number of distinct business lines, but that it also might impair the safety and soundness of the banking system, weaken market integrity, and lead to an excessive concentration of economic power.

Our Article contributes to the debate by empirically examining an important episode in the U.S. commodities market following the 2008-2009 financial crisis, when financial institutions sought to take advantage of depressed commodity prices by amassing unprecedented metals inventories. From 2010 through 2014, as financial institutions held over half of the total U.S. aluminum stock in Detroit warehouses, the time it took to remove metal from warehouses increased from days to years and the regional price of aluminum skyrocketed—a surreal phenomenon because aluminum is one of the most actively traded commodities in the world and is used in the production of industrial goods from beverage cans to cars and airplanes.

We first demonstrate that the market distortion was caused by certain banking organizations and then show that the distortion harmed businesses and consumers. We argue that the unprecedented accumulation of commodities was made possible by a statutory loophole created by the Gramm-Leach-Bliley Act of 1999, one that advantages certain investment banks and enables them to undertake activities that are more commercial in nature. We recommend closing the loophole as well as modifying other facets of the banking-and-commerce legal framework. We then propose a detection algorithm to guard against non-bank financial institutions, which are outside the perimeter of the banking-and-commerce framework, from causing similar market distortions in the future.

Notably, the 2010-2014 episode may recur. The legal framework remains unchanged and financial institutions respond to incentives. Solving this problem will require action from Congress as well as coordination among the Department of the Treasury, Federal Reserve, and Commodities Future Trading Commission.