Key to Future Bank Performance: How to Get Around the Regulations

Interested in investing in a commercial bank these days?

What should be the key factor in determining whether or not to invest in a specific bank?

How about the ability of the management of the bank to get around the rules and regulations now being written up or proposed by the bank regulatory agencies?

A New York Times article this morning, “Consumer Inquiry Focuses on Bank Overdraft Fees” contains the following subtitle: “Wondering whether banks are working around new rules.” (http://www.nytimes.com/2012/02/22/business/bank-overdraft-fees-to-be-scrutinized-by-consumer-bureau.html?_r=1&ref=business)

My answer?

Yes!  The banks are working around new rules!

I began my banking career in the 1960s, a period when commercial banks began the process of financial innovation that just grew and grew through the latter part of the century.  In that decade we saw the introduction of the negotiable certificate of deposit (negotiable CDs), the formation of bank holding companies, the issuance of bank liabilities through the bank holding companies, and the creation of the Eurodollar.  Then we saw banks attempting to get around state branching laws and interstate branching laws and so on and so forth.  The rest is history!

When I was working in the Federal Reserve System in the late 1960s and early 1970s the “rule of thumb” was that the Fed was about six months behind what the commercial banks were doing.  New rules or regulations would go into effect on the banking system…the commercial banks would move to “get around” the new rules or regulations…and, it would take about six months for the Fed to catch on to what the commercial banks were doing.

Times haven’t changed…and won’t change.

Given the rapidly changing environment created by information technology, the financial institutions will just have more ways to quickly and effectively avoid any banking rules or regulations they believe it is worthwhile to avoid.

To me, what Congress and the regulators are trying to do is silly!

For one, the “powers that be” are trying to avoid 2007-2008 from happening again.

Guess what?

2007-2008 will not happen again.  We have already moved way beyond that.

Furthermore, the technology has changed to the point where it is almost impossible for regulators and legislators to understand what is going on, let alone write rules and regulations that will control what is going on. 

Look at the Dodd-Frank financial reform act.  Most of the rules and regulations included in this bill HAVE NOT BEEN WRITTEN YET!

And, President Obama signed the act into law in July 2010.  We are ready to celebrate the 2^nd anniversary of the signing of the bill and the most of the rules and regulations incorporated into the bill have not been written.

And where is this “writing” taking place?  Primarily in back rooms, with no intrusion from the public, and no review.  See the enlightening piece in the Wall Street Journal this week, “Fed Writes Sweeping Rules From Behind Closed Doors.” (http://professional.wsj.com/article/SB10001424052970204059804577225122892450312.html?mod=ITP_pageone_0&mg=reno64-wsj)

Here are some of the goodies: “the Fed has held 47 separate votes on financial regulations, and scores more are coming.  In the process it is reshaping the U. S. financial industry by directing banks on how much capital they must hold, what kind of trading they can engage in and what kind of fees they can charge retailers on debit-card transactions.”

I understand that one rule relating to when Governors of the Federal Reserve System could go to the bathroom has been removed.  The writers of the rules did not want to get into gender differences they felt were necessary and instead of raising this issue…they just dropped the whole provision.

 These rules and regulations do have effects.  The problem is that they may not always have the effects that are desired. 

In some cases they do.  For example, in the New York Times we read the headlines: “Under Volcker, the Old Dividing Line in Banks May Return.” (http://dealbook.nytimes.com/2012/02/21/under-volcker-old-dividing-line-in-banks-may-return/?ref=business)  That is, financial institutions may divide back into the distinction between commercial banks and investment banks.

This is just what Paul Volcker would like to have happen.

However, in many other cases, the rules and regulations will result in outcomes that are far from what was intended by Congress or by the regulators that wrote the regulations.  What those outcomes might be are, of course, unknown because they haven’t happened yet.

And, some of the outcomes may be totally unexpected because the outcomes will be related to the new things that information technology will allow institutions to do.  In five years, finance may be done in an entirely different way than it is now.  (See my forthcoming review of the new book “The End of Money,”)

What bank…or financial institution…should one invest in? 

Congress and the regulators have created so much uncertainty in the world of banking that it is almost impossible to say anything about bank performance in the future.  All bets on banks are nothing more than gambling, at this stage. 

I do not expect this environment to change much in the near future.  Investing in banks is not where I would want to put my money at this time because there is nothing really to base an investment decision on when it comes to the banking industry.