In the New York Times Deal Book, Professor Steven Davidoff Solomon writes about new steps to disapprove merchant banking by the FED to reduce risk but at high cost. From an Islamic point of view, it just looks like another door for equity investments by the banking sector is about to be shut down, while the contrary makes sense in times of an ongoing debt crisis.
Professor Solomon defines Merchant Banking as ""simply the practice of buying operating companies. The risk to a bank holding company is twofold. First, the bank could lose its money — as with any investment. Or second, it could be held liable for the debts of that company." Already he outlines that "banks are penalized for these investments by having a charge applied to their allowable capital. Second, the bank must sell the investment within 10 years, a period that can be extended by application to 15 years. These investments are monitored heavily these days to ensure they are not unduly risky."
The step of the FED to close the remaining limits for equity investments are criticised as such: "Indeed, in the Fed’s report, there was no data on whether merchant banking was profitable, whether banks were held liable for it or whether it was indeed risky. In fact, there was no data at all. Nor was there any consideration of the downsides to this ban, like the loss of an investor in growth businesses and smaller profits for banks, presumably meaning less credit."
The full text can be found here.
One wonders, how long it will take till authorities start promoting equity finance to create a sustainable financed economy.