Many countries came to support their domestic commercial banks during the meltdown of 2008. Following these ‘bail-outs’, the United States and Europe decided to review the banking legislation. They sought to eliminate the excesses of the past, considered to be at the root of this financial demise.
Certain activities were stopped and others reduced, under the watchful eye of regulators in charge of implementing these new rules. On top of this, the banking industry was asked to reinforce its capital footprint. The declared objective was to avoid soliciting any future taxpayer money for the next crisis.
The overall cost of these interventions was very high. The governments concerned saw their national debt rise significantly. In some cases, this even led to the implementation of austerity policies. Commercial banks tried desperately to comply with the new rules imposed on them. Some even shied away from private sector lending, preferring to fund the public sector (now heavily indebted).
Sovereign public debt is considered less risky for banks under their investment regulation. The result has been weak economic activity in some areas (sub-potential growth) while in others it has been anemic. Faced with slow growth, world Central Banks have resorted to unconventional accommodating monetary mechanisms in the hope of jump-starting these ailing economies.
With fragile economic activity, a policy of low interest rates and higher new capital requirements to pay for, margins on traditional activity has been insufficient, at times, to cover bank financial needs. To some extent, technology has counterbalanced this phenomenon.
Many larger players have heavily invested and successfully improved their operational efficiency, underpinning their bottom line profitability and compensating the weakness in their top line revenue growth. In spite of this, the financial situation of banks remains precarious. Their activity depends on the underlying economy in which these entities operate.
In this context, American banks have sought to push for some changes to the new rulebook. They have focused their attention on the ‘Volcker rules’ considered to be too constraining for their financial market activity (the Volcker rules essentially cover market making and prop-trading restrictions). For one who understands the value of rising financial markets, Mr Trump has been open to entertaining this request. As he sees it, stronger and more profitable banks combined with higher markets could only add to the country’s growth prospects.
The political debate is now open for an adjustment of these rules. Once in place, American Banks will be able to boast of a triple competitive advantage: a resilient economy in which they operate, (the United States is doing relatively better than its European and Japanese counterparts), healthy lending margins supported by positive interest rates (still), and now potentially watered down rules compared to those of their direct foreign competitors.
When ‘tweeking’ the rulebook, the challenge for the authorities is to avoid a return of the excesses of the past. Since 2008, the policy of self-regulation supported by Mr Greenspan and Mr Bernanke has been dismantled. Today, the US regulator has the capacity to find an appropriate balance to undertake such reforms. It has a full set of legal tools at its disposal, which was not the case ten years ago.
Column by Ygal Cohen, President, CEO, and Founding Partner of ASG Capital