By David Reilly
Be careful what you wish for. Bank investors bid up bank stocks after the election partly on hopes of a lighter regulatory load. President Donald Trump's executive order mandating a review of financial regulation and the Dodd-Frank Act would seem to confirm that expectation.
A reopening of the post-financial-crisis regulatory order can hold peril, as well as promise, for big banks, though.
The administration and many congressional Republicans have made a point of saying the overhauls enacted in the wake of the 2008-2009 meltdown have failed to solve the problemof banking behemoths. Speaking with reporters Thursday night, a senior White House official explaining the administration's intentions said, "We really never have dealt with too big to fail."
In one sense, that is true. The biggest banks -- J.P. Morgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup Inc. -- have in many cases grown since the crisis. Goldman Sachs Group Inc. and Morgan Stanley, while down from their peaks, are nearly as big as they were in the immediate run-up to the credit crunch.
Instead of forcing the banks to dramatically shrink, or even break up, the Obama administration and the Federal Reserve favored an unspoken policy of giving banks a choice: stay big and get treated like a utility, or shrink and gain some freedom. Most have chosen the former route.
And regulators' assertions that they would allow big banks to fail had a hollow ring to them. True, the new regulatory framework stressed things like so-called living wills, which were meant to provide a road map to regulators and banks for failing a struggling institution. But experience in Europe has shown that when a failure would force losses onto politically favored groups, usually retail investors, political tends to be lacking for such drastic actions.
So, one thing the Trump administration could do is clearly spell out what it expects of banks, and how it will ensure that there is no bailout backstop for them. That medicine may prove unsettling, though.
While the administration isn't likely to call for bank breakups based on size, reopening Dodd-Frank will likely lead to renewed debate on that front. This could jar investors.
More likely, the administration or congress could choose to more clearly define what is backstopped by the government and deposit insurance and what isn't. Again, investors would have reason to be wary.
The danger is that this pushes up banks' cost of capital if markets became truly convinced that a big bank could fail. While that could be good from a systemwide perspective, it could prove painful short term for some individual firms.
And any attempt to ringfence certain portions of banks' businesses could make them less nimble, especially in times of stress. It may also lead to less efficient uses of bank balance sheets and so more subdued returns.
Of course, there is also great opportunity. If banks are required to hold less capital, they can return more of it to shareholders, boosting returns and justifying higher valuations. A lighter regulatory load also should lead to reduced compliance expenses, helping profits.
The big question, though, is whether any new overhaul will be evolutionary or revolutionary. The more the regulatory landscape changes, the longer it will take banks to adjust to it. That is likely why top bank executives have talked more of the need for the existing rule book to not grow, rather than it being thrown out entirely.
Change could prove a boon for banks. It's just that there also could be too much of a good thing.
Write to David Reilly at email@example.com
(END) Dow Jones Newswires
February 03, 2017 13:17 ET (18:17 GMT)
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