What is a 'Firewall'

A firewall is a legal barrier preventing the transference of inside information and the performance of financial transactions between commercial and investment banks. Restrictions placed on collaborations between banks and brokerage firms under the Glass-Steagall Act of 1933 acted as a form of firewall. This works similarly to firewall software and hardware used in preventing or limiting outside access to a company's internal servers and networks.


A firewall refers to stipulations in the Glass-Steagall Act of 1933 that mandate strict separation of banking and brokerage activities in full-service banks and between depository and brokerage institutions. There are varying opinions on the purpose of the firewall. Some believe that just as a physical firewall prevents fire from spreading in a building, the financial firewall protects depositors from high risks of investment banking. Others believe the firewall was a political method of keeping sectors of the financial industry from lobbying together and undermining financial regulation. In other words, the financial institutions were prevented from dividing and conquering other sectors of the economy.

Firewall Example

Before the Great Depression, investors borrowed on margin from commercial banks to buy stocks. Anticipated capital appreciation was expected to pay back the loan. Especially during the rapid growth period in the two previous decades, the practice was legal and acceptable. Because banks used regular depositors’ money to fund the loans, the depositors were exposed to high-risk levels. The Great Depression caused much-needed, government-mandated reforms in the financial industry to stop brokerage activities from risking depositors’ money.

Political Impact of the Firewall

Separating investment banking from commercial banking ensured sector battles whenever new products were developed. Congressional members could alienate one sector and still find campaign support from another. Attempts to deregulate a sector was stopped by litigation challenges from other sectors.

Politicians in recent times have pitted industry sectors against each other to also promote regulation. Banks and retailers debated over the 2010 Durbin Interchange Amendment regulating merchants’ debit card swipe fees. Big banks fought large retailers when JPMorgan opposed Wal-Mart. The banks lost in both cases.

When the Glass-Steagall Act was repealed by Bill Clinton in 1999, massive deregulation of the financial services industry began and contributed to the 2008 financial crisis. Financial firms united as subsidiaries of financial holding companies. Industry trade associations united and pushed through large deregulatory legislation. As a result, too-big-to-fail banks are riskier than ever. The politics of financial regulation should be addressed to avoid another economic crisis.

  1. Commercial Bank

    A commercial bank is a type of financial institution that accepts ...
  2. Bank

    A bank is a financial institution licensed as a receiver of deposits. ...
  3. Deregulation

    The reduction or elimination of government power in a particular ...
  4. Business Banking

    Business banking is a company's financial dealings with an institution ...
  5. Universal Banking

    Universal banking is a banking system in which banks provide ...
  6. Emergency Banking Act Of 1933

    A bill passed during the administration of former U.S. President ...
Related Articles
  1. Investing

    Cisco Ups Its Data Security Game WIth New Firewall

    Following the Feb. 15 announcement of what was generally considered a so-so second-quarter fiscal 2017, Cisco (NASDAQ: CSCO) stock  has climbed 4%. That might surprise some investors, but it ...
  2. Insights

    Financial Regulations: Glass-Steagall to Dodd-Frank

    Here are some of the most important financial regulations that have been established.
  3. Insights

    A Brief History of U.S. Banking Regulation

    From the establishment of the First Bank of the United States to Dodd-Frank, American banking regulation has followed the path of a swinging pendulum.
  4. Insights

    Trump to Revive Glass-Steagall, Break Up Banks

    President Donald Trump hinted that he is looking at ways to break up giant Wall Street banks.
  5. Investing

    How Do Financial Regulations Affect Smaller Banks?

    Not to big to fail? We explain how US financial regulations affect smaller banks.
  6. Insights

    The World's Top 10 Banks

    Learn more about the world's largest banks and how more financial power shifts eastward as China is home to four of the world's largest banks.
  7. Insurance

    Insurance Companies Vs. Banks: Separate And Not Equal

    Insurance companies and banks are both financial intermediaries. However, they don't always face the same risks and are regulated by different authorities.
  8. Investing

    Fidelity Investments Makes the Case for Banking at a Brokerage

    Forget banks – Fidelity offered up some reasons to conduct financial transactions at your brokerage.
  1. How are investment banks regulated in the United States?

    Read about the extensive regulations placed on investment banks in the United States, beginning with the Glass-Steagall Act ... Read Answer >>
  2. What agencies were created by the Glass-Steagall Act?

    Learn about the Glass-Steagall Act of 1933 that significantly reformed the banking industry, and specifically, what government ... Read Answer >>
  3. How does investment banking differ from commercial banking?

    Discover how investment banking differs from commercial banking, the responsibilities of each and how the two can be combined ... Read Answer >>
  4. What is the difference between the Volcker Rule and the Glass-Steagall Act?

    Read about the differences between the Volcker rule and provisions in the Glass-Steagall Act, two attempts at regulating ... Read Answer >>
  5. What is the banking sector?

    Why the banking sector is a vital industry, what it does to drive economic growth and examples of companies in this sector. Read Answer >>
  6. Why is the capital adequacy ratio important to shareholders?

    Understand what the capital adequacy ratio is and why it is a very important metric of financial soundness for evaluating ... Read Answer >>
Trading Center