Wednesday, March 7, 2012

Bank Regulations Costly to Bank Shareholders

Recently, I wrote a piece on whether or not this is the time to invest in commercial banks. (  I concluded that if one wanted to invest in a commercial bank at this time, the best ones to invest in would be those that are going to be most adept at working around the regulations and the regulators.

Larry Tabb, the CEO of the Tabb Group, reprises another argument about the impact of the “alphabet soup bowl” of proposals and regulations that are now facing the banking industry.  All of this bank regulation, he argues, will impact commercial bank shareholders…and the commercial banking industry, itself. (

Almost everything the new regulations require will raise costs.  Here are some examples Mr. Tabb gives:

Increasing banks reserves increases the cost of bank capital;

Pushing derivatives towards central clearing leading to  trading on exchanges or swap execution facilities will change how banks charge customers;

The Volcker Rule will push banks from “risk-based profit model” to one based more on transactions fees;

As principal risk is replaced by fees, bonuses and salaries will be cut causing higher-paid individuals to leave the banks;

As banks assume less risk, more risk will be shifted to investors and issuers;

As the fee-based model spreads, banks will become brokers and brokers work off of spreads and this will cause spreads and trading costs to increase;

Widening spreads, resulting in less market liquidity, will increase issuer costs resulting in decreases in turnover and this will result in higher costs for companies and governments to borrow;

More over-the-counter markets will resemble the equities market;

Less regulated intermediaries will come on the scene and employ speed over balance sheet management;

High frequency trading, whose volume comprises over 50 percent of the market, will look more and more desirable because execution is fast and the banks won’t take on much risk;

More limited bank exposure will be hailed because it seems to lessen the need for bailouts;

The risks that are inherent in the newer, less regulated intermediaries will be unknown;

The apparent transparency of these new markets around a centrally cleared market “will only increase the volume in these products.”

And, the cycle will go on!

One does not have to agree with everything that Mr. Tabb presents to come to the following conclusion: the new regulations are going to be expensive and the cost of these new regulations will be carried, ultimately, by the shareholders of the commercial banks.

Furthermore, the new regulations will be the driving force behind a whole new series of financial innovations not unlike those which have “been blamed for the destabilization of the housing market, the instability of European sovereign debt and the ability to manipulate corporate and sovereign borrowing costs and creditworthiness.”

Regulations have consequences.  Mr. Tabb is claiming that the new banking regulations will raise bank costs and create incentives for banks to innovate and work around the regulations.

I have constantly argued that advances in information technology are going to change the structure of banking and finance dramatically.  I firmly believe that the imposition of the new rules and regulations is just going to accelerate this re-structuring. 

 Banking and finance are going to be quite different in the future.  Right now it is hard to tell who will be the winners of the transition.  If history is any guide in this, the future will belong to the newer, less regulated intermediaries than to the entrenched “legacy” institutions.

And, according to Mr. Tabb, “the new rules may or may not preclude another (financial) crisis.”

Stay tuned!

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