This is especially true for banks, which are operating in an intensely competitive and dynamic environment. They need to muster all their talents and energies on the financial business, instead of dissipating them over many different businesses. For these reasons, banks should not commingle financial and non-financial activities. However, this does not mean that banks must refrain from engaging in venture capital or merchant banking business, which involves taking an equity interest in a diversified portfolio of non-financial companies for some period. It is not uncommon for the merchant banking business of well-run, international banks to take stakes in non-financial companies for three to five years. These activities are natural extensions of the lending business of banks. They are, however, quite different from taking long-term strategic stakes in non-financial companies which tie a bank’s reputation to these companies. In addition to the separation of banking and non-banking activities, regulators in several developed markets have also advocated dispersed ownership of banks. Often this has been achieved by legislation or via the bank’s own memorandum and articles of association, which sets limits on shareholdings to prevent any single shareholder or group of shareholders from dominating the bank. The result has been a “clean” corporate structure for their banks, i.e. there are no cross-shareholdings between banks and non-banks, and there is clear separation of ownership from management. Practice in other countries The US is an example of a financial system which has prohibited commingling between banking and commerce, and required dispersion of bank ownership.

The Germans have recognised these structural weaknesses and are taking steps to rectify them. However, one major obstacle to German banks divesting their industrial holdings has been the prohibitive capital gains tax. Now a Social Democrat government has proposed tax reforms that will remove this obstacle, and pave the way for banking and industrial conglomerates to untangle their web of cross shareholdings. In Asia, both South Korea and Japan relied on close association between banking and commerce in the earlier stages of their industrialisation. South Korean chaebols, and the banks that lent to them, are now facing painful reforms. Poor lending practices by Korean banks disguised the deteriorating finances of the chaebols, and eventually nearly brought the whole system down in the Asian crisis. In Japan, the pre-war zaibatsu system became the post-war keiretsu system. Each major keiretsu or industrial group consists of companies linked together through a web of cross-shareholdings, including a main bank. Keiretsu members support one another financially and in terms of direct business. The bank in the keiretsu plays a pivotal role, facilitating the financial transactions of the group. While the keiretsu system helped Japan to rebuild and industrialise its economy after the war, many of the problems of corporate governance and unsound banks that now plague Japan are rooted in this structure. The prolonged crisis of the Japanese economy since 1990 has forced a fundamental rethink. The Japanese are now gradually starting to make basic structural changes.