After the election of Donald Trump as US president, lots of the more excitable commentary predicted a proper bonfire of the regulations holding back America’s animal spirits, particularly in the financial industry. Even GlobalCapital joined in, predicting, seemingly correctly, that a Commodity and Futures Trading Commission run by Christopher Giancarlo, rather than Timothy Massad, would smooth some of the rougher edges of derivatives regulation.
In banking, though, it was always going to be more complicated. US banking regulation sprawls over multiple federal and state bodies, some of which — like the Federal Reserve — have few practical ways in which the political administration can coerce them. It also, in theory, takes its cues from the international Basel Committee on Banking Supervision agreements, where US regulatory bodies have been a driving force behind the planned Basel IV proposals.
Much of the recent rulemaking in US banking is encoded in the Dodd-Frank Act, where, again, “sprawling” has to be the adjective of choice. The 848 pages of the source text only scratch the surface of what Dodd-Frank means, with dozens of implementing measures and guidelines explaining how banks are actually supposed to apply it.
That means, even if it was politically possible, it’s not just a case of scratching out the legislation and putting nothing in its place. There’s a thick layer of market practice, convention, banks’ internal organisation and other elements that need to be unpicked.
Perhaps some high profile measures, such as the Volcker Rule prohibiting banks from proprietary trading and co-investing their own capital in private equity and hedge funds, could be struck from the record without difficulty, but it’s unlikely this would return the capital markets to their pre-crisis state.
Investors in bank equity might have enjoyed 20% ROEs while they lasted, but are unlikely to want a return to debt fuelled position taking or a major run-up in leverage. It isn’t just regulation that’s forced a run-up in bank capital levels. There was an actual financial crisis which occurred. It’s not as though bank chief executives, after eight years of telling their shareholders how well capitalised and risk averse they are, can just pull off a mask and say “hey we were just kidding about all that”, and head right back to pre-crisis business models. Those days are over, forever.
Practically the only easy win would be to gut the Basel-driven operational risk rules, which force banks to set aside huge amounts of capital based on previous fines, settlements, and unforced errors. If you have been heavily fined in the past, this closes the case, making you less likely to incur fines in the future, but the rule works the opposite way, and past fines increase the amount of operational risk-weighted assets the bank must capitalise. JP Morgan has around $400bn in op risk RWAs; BAML has $500bn, which require idle capital. Those assets do not support lending, market making, or anything else.
But that still requires international co-operation, and for the moment, that doesn’t look likely.
Far more important has been the steepening yield curve and the ascent of US Treasury yields from rock-bottom. Higher absolute yields mean the bid-offer cost of trading drops as a proportion of total bond return. Speculation on the timing and magnitude of interest rate increases opens up trading opportunities and creates client flow.
And, of course, there’s maturity transformation. Despite all the liquidity and asset-liability matching rules passed since the crisis, banks are still in the business of borrowing short and lending long. Any curve steepening is good news for bank profitability, whatever the business model and whatever the regulatory environment.
Bank investors don’t have to choose one or the other to get excited about — the double-digit increases in US bank share prices since November 9 suggests a broad-based enthusiasm driven by multiple factors — but Fed rate hikes should already have been factored into the price. The new information provided by Trump’s victory is the possibility of deficit infrastructure spending (likely to be blown up by Congress) and the possibility of deregulation.
Neither prospect, however, is going to be easy, or a quick fix for the difficulties of the banking system. Better to ground the case for the revival of the banks on certainties of a steeper yield curve, rather than the phantom of regulatory easing.