Banking Act of 1933 (Glass-Steagall Act)

The law passed during the first months of Franklin D. Roosevelt’s administration that defined the scope of American banking for the rest of the century. It was passed as a result of congressional hearings (the Pecora hearings) investigating the causes of the crash of 1929 and the banking and stock market problems of the 1920s and 1930s. An act of a similar name passed Congress the previous year relating to the gold reserves of the United States.

The act defined the bounds of American banking. It listed the activities that a commercial bank could carry out while restricting others. Specifically, it effectively prohibited commercial banks from engaging in INVESTMENT BANKING, requiring banks that practiced both sides of the business to decide within a year which side they would choose. It did so through Section 20 of the law prohibiting commercial banks from being “engaged principally” in underwriting or trading equities, meaning that they could earn only a limited amount of their total revenue from equity related activities. The section effectively made dealing or investing in stocks impossible for commercial banks and precluded them from the investment banking business.

The exclusion was aimed at the large New York money center banks, notably J. P. Morgan & Co., which traditionally had practiced a mix of commercial and investment banking and had holdings in insurance companies as well. The National City Bank and the Chase National Bank were also heavily involved in both commercial and investment banking and were the focus of the hearings and the new law. By excluding commercial banks from holding equity, the act made expansion into other related financial services difficult and in many cases impossible.

The Banking Act also created deposit insurance through the FEDERAL DEPOSIT INSURANCE CORPORATION. Almost half of all American banks failed during the Depression, and several hundred per year were failing on average before the act was passed. As a result, many depositors withdrew their funds at a crucial time, and many banks were short of funds for lending. The “money horde” was responsible for the diminution of credit when unemployment was rising and capital expenditures waning, and the introduction of deposit insurance on a national scale helped restore faith in the banking system. There was much criticism of deposit insurance at the time, with some detractors calling it socialist or simply not necessary. But when the act passed, after a weeklong banking holiday, depositors began to return to banks.

Also included in the act was Regulation Q (Reg Q) of the FEDERAL RESERVE, which allowed the central bank to set interest rate ceilings on deposits in order to prevent banks from entering a bidding war for savers’ funds. In the following decades, this provision protected banks from paying the market rate for deposits and effectively protected the banks’ cost of funds. Interest on checking accounts was also prohibited. These regulations lasted for more than 40 years.

The major restrictions in the Glass-Steagall Act were lifted gradually over a period of years. In 1980, the DEPOSITORY INSTITUTIONS DEREGULATION AND MONETARY CONTROL ACT increased the amount covered by deposit insurance and permitted interest-bearing checking accounts. Reg Q was also phased out by the act and disappeared after the DEPOSITORY INSTITUTIONS ACT was passed in 1982. It was not until 1999, when the FINANCIAL SERVICES MODERNIZATION ACT was passed, that commercial banks were again free to own investment banking and insurance subsidiaries, although the Federal Reserve had been allowing the practice on a de facto basis since the early 1990s. In response to pressures from the marketplace, Congress passed that act, effectively rolling back the major restrictions of the Glass- Steagall Act and creating a more liberal banking and investment banking environment.

The Banking Act of 1933 was the most restrictive banking law ever passed. When combined with the McFadden Act of 1927, it created a peculiarly American style of banking found nowhere else. For decades, it was considered part of the “safety net” that protected savers and the banking system itself.