Universal Banking: Definition, Functions, Regulation

What Is Universal Banking?

Universal banking is a system in which banks provide a wide variety of comprehensive financial services, including those tailored to retail, commercial, and investment services. Universal banking is common in some European countries, including Switzerland.

Universal banking became more common in the United States starting in 1999 when the Gramm-Leach-Bliley Act (GLBA) repealed the restrictions preventing commercial banks from offering investment banking services. Proponents of universal banking argue that it helps banks better diversify risk. Detractors think dividing up banking operations is a less risky strategy.

How Universal Banking Works

Universal banks may offer credit, loans, deposits, asset management, investment advisory, payment processing, securities transactions, underwriting, and financial analysis. While a universal banking system allows banks to offer a multitude of services, it does not require them to do so. Banks in a universal system may still choose to specialize in a subset of banking services.

Universal banking combines the services of a commercial bank and an investment bank, providing all services from within one entity. The services can include deposit accounts, a variety of investment services, and may even provide insurance services. Deposit accounts within a universal bank may include savings and checking.

Under this system, banks can choose to participate in any or all of the permitted activities. They are expected to comply with all guidelines that govern or direct proper management of assets and transactions. Since not all institutions participate in the same activities, the regulations in play may vary from one institution to another; however, it is important not to confuse the term "universal bank" with any financial institutions with similar names.

The History of Universal Banking in the U.S.

Due to strict regulation, the universal banking system was slow to grow in the United States. During the Great Depression, Congress passed the Glass-Steagall Act as part of the Banking Act of 1933. In a measure to prevent further bank failures, the act prohibited universal banking.

Commercial banks were not allowed to provide investment banking services, such as securities trading and brokerage services. Additionally, the act established the Federal Deposit Insurance Corporation (FDIC), an independent federal agency that insures U.S. bank deposits against bank failure.

In 1999, the Gramm-Leach-Bliley Act (GLBA) partially repealed the Glass-Steagall Act, thus making it legal for commercial banks to offer investment banking services. The goal of the GLBA was to modernize the financial services industry by allowing financial institutions to expand the products and services they could offer their customers.

Financial Crisis and Changing Regulations

Laws impacting universal banking in the U.S. have continued to evolve and change, especially during times of economic upheaval. For example, the 2008 financial crisis caused a number of failures within the investment banking system in the United States. This led to the acquisition or bankruptcy of a variety of institutions. Some notable examples include Lehman Brothers and Merrill Lynch.

In response, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, which restricted the ways in which banks could invest by limiting speculative trading and prohibiting involvement with hedge funds and private equity firms.

Opponents of Dodd-Frank criticized the act for going overboard in reducing the market-making activities of banks. In 2018, Congress enacted the Economic Growth, Regulatory Relief, and Consumer Protection Act (also known as the Crapo Bill), which rolled back some of the Dodd-Frank restrictions.

Despite the evolving rules regarding universal banking, many financial service providers in the U.S. today offer a range of services from banking, loans, mortgages, insurance, and investments either under one roof or through an affiliate network with partner firms.

While developments have removed a number of the barriers to the creation of universal banks in the U.S., they are still not as prevalent as they are across many European countries. The United States has banks that focus purely on investments, which is uncommon in the rest of the world.

The Bottom Line

Universal banking refers to when banks provide a wide array of financial services, including commercial banking, investment banking, and retail banking. Regulations surrounding what banks can provide have changed over time in the U.S., primarily to protect bank clients while still remaining competitive.