Why are commercial banks prohibited from entering the investment banking arena?

The prohibition of commercial banks from entering the investment banking arena primarily stems from the high risks associated with investment banking activities. Investment banking involves facilitating capital raising for businesses, underwriting securities, and engaging in trading and market making, all of which entail significant financial risk and volatility. By separating these functions, regulators aim to protect the stability of the banking system, ensuring that the commercial banking sector, which deals with consumer deposits and traditional lending, is insulated from the potential losses and speculative nature of investment banking.

This separation helps maintain consumer confidence in commercial banks and prevents situations where high-risk investment activities could jeopardize the safety of depositors’ funds. Regulatory frameworks such as the Glass-Steagall Act historically addressed these concerns, reinforcing the need for distinct lines between commercial and investment services to create a more stable financial environment.

The other considerations, such as conflicts of interest, domestic legal restrictions, or expertise in securities trading, while relevant to the overall discourse on banking regulations, do not encapsulate the fundamental reason related to managing financial risk and maintaining market stability which is at the heart of the prohibition on commercial banks engaging in investment banking activities.