Question

What are the key issues in wholesale banking? In the context of commercial and investment banks, examine the lender of last resort function of the central bank, and explain the role of moral hazard.

Answer 1

The primary issue of wholesale banking is technology disruption. With rapid advancements in technology client expectations are also changing and are undergoing a dynamic shift. Wholesale banking is now expected to provide consistent digital experiences to its clients and customers. While the IT infrastructure is scalable many wholesale banking entities are finding it expensive to cope up with technological advancements. Legacy costs are often too high. Another key issue of wholesale banking is that they are constantly under immense regulatory pressure and are constrained by legacy technology as well in some cases. Lastly their culture is not suited to rapid change.

In the context of commercial and investment banks the lender of last resort function of the central bank entails the central bank offering loans to commercial and investment banks that are experiencing financial difficulties or are on the verge of collapsing.

Moral hazard is present in this function of the central bank. This is because this function of the central bank often causes commercial and investment banks to become reckless. Commercial and investment banks often end up taking incremental quantum of risks because of this function and this can lead to serious repercussions in the long run. For example many institutions that took unwarranted risks before the 2008 financial crisis collapsed and were rescued by the Federal Reserve. There is no guarantee that these entities will not be reckless in future again.