In the European Union, Capital Requirements Directive IV (‘CRD IV’), art. 8(1) and art 9(1) contain the principle that undertaking banking (“credit institution”) activities requires an authorization. EU Member States “shall require credit institutions to obtain authorisation before commencing their activities” and “shall prohibit persons or undertakings that are not credit institutions from carrying out the business of taking deposits or other repayable funds from the public”. One is a credit institution when one takes deposits or other repayable funds from the public and grants credits for its own account. That activity can only be undertaken once one has a banking license. But banks can undertake a number of other activities, and charge customers for it, for which other licenses would otherwise be required. For instance undertaking payment services as defined in art. 4(3) of Directive 2007/64/EC (‘Payment Services Directive’), but annex I of CRD IV also allows participation in securities issues and the provision of services related to such issues, advising to undertakings on capital structure, industrial strategy and related questions and advice as well as services relating to mergers and the purchase of undertakings, trading for the account of customers (in money market instruments, foreign exchange, financial futures and options, exchange and interest rate instruments and transferrable securities), money broking, portfolio management and advice, safekeeping and administration of securities, safe custody services and issuing electronic money.
The type of sources where banking (“credit”) institutions can make their money from while using deposited money from customers, is subject to constant debate. Most people will consider interest income from creditworthy commercial and private loans safe, whereas derivate contracts where the payment of the counterparty is dependent on various uncontrollable factors will be considered as more risky. Still, the former type of income source is less scalable – there are only so many businesses and private persons that need a loan or that are able to pay back a loan. The customers are not much at risk, but not much money can be made for the banker. The latter type of possible income source is scalable: derivative contracts and instruments can be taken up as long as counterparties are willing to produce them. And if things go well, then the upside can be very high (especially considering the proportion of the initial investment). It is only when things go wrong that they can also wipe out the entire initial investment whereas a pool of safe loans may still see the initial money back to a large degree. Much money can be made for the banker, but the ones who provide money to the bank are exposed to events with a much more dramatic impact if they realize.
In the US, the Volcker Rule (Section 619 of the Dodd Frank Act), restricts deposit-taking banks for instance from using the money for proprietary trading and to speculate on income from such activity. They can still make loans with the money they obtain from deposits, though. In the EU, this source of money making is not prohibited as such, even when a bank mainly obtains its money to work with from deposits. Proprietary trading for the account of customers (in money market instruments, foreign exchange, financial futures and options, exchange and interest rate instruments and transferrable securities) is included as permitted activity in Annex I of CRD IV (although subject to mutual recognition by Member States). But a recent Liikanen Report proposes a rule where the proprietary trading activity must be split off into a separate entity as soon as a threshold is crossed.
Another problem that exists, is the incentives that bankers would have to channel the money into uses that most suit their interests, but not necessarily those of the customers that provided the money. They might for concentrate a very high proportion of their investable money into one stake – and possibly even where they for instance seek ownership and controlling stakes in an industrial entity. Conflict of interests are in EU law mainly regulated through art. 89(1) of the CRR which foresees for holdings that exceeds 15 per cent of the eligible capital of the institution, that banks can only take up such holdings when they are of a financial nature, such as (a) ‘a financial sector entity’ and (b) a holding in an undertaking that is not a financial sector entity, carrying on activities which the competent authority considers to be any of the following: (i) a direct extension of banking; (ii) ancillary to banking; (iii) leasing, factoring, the management of unit trusts, the management of data processing services or any other similar activity’. Also, art. 89(3) of the CRR says that the total industrial holdings by a credit institution must not exceed 60 per cent of the eligible capital of that bank.