Bank Regulations Costly to Bank Shareholders

Recently, I wrote a piece on whether or not this is the time to invest in commercial banks. (http://seekingalpha.com/article/389321-with-regulations-in-limbo-this-is-not-the-time-to-invest-in-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. (http://www.ft.com/intl/cms/s/0/695b0230-677d-11e1-b6a1-00144feabdc0.html#axzz1oR0duVqd)

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!

   

FDIC Statistics: Larger Banks Doing Better Than Others

The FDIC statistics were released this morning.  The larger banks continue to prosper relative to the rest of the industry.  The larger banks in this case are those that are larger than $1.0 billion in asset size. 

For one, over the past year, the number of larger banks in the United States rose by 5 whereas the rest of the commercial banking system shrunk by 245 banks.  Of the total reduction in commercial banks in the United States of 240 in 2011, only 92 banks were closed by the FDIC. The rest were merged into other organizations. 

A total of 185 banks smaller than $100 million in asset size were closed.

At December 31, 2011, the commercial banking system had 62 fewer banks than on September 30, 2011.  Of this number, 66 were smaller than $100 million in assets.  The FDIC closed only 18 banks in the fourth quarter.

In terms of lending, net loans and leases at the largest 514 banks in the country rose by about $194 billion in 2011, with $137 billion of the increase coming in the fourth quarter of the year. 

This increase is coming in the face of an improving loan portfolio.  Noncurrent loans and leases at these larger banks fell by $44 billion over the past year while the loan loss allowance at these banks dropped by $38 billion.

It appears that the largest commercial banks in the country are feeling better about their loan portfolios and are becoming much more aggressive in actually making new loans. 

This is not the case for the other banks.  For banks that hold assets somewhere between $100 million and $1.0 billion, net loans and leases actually declined by about $31 billion in 2011.  For the fourth quarter of the year net loans and leases held about constant. 

For commercial banks with less than $100 million in assets loans declined by about $8 billion for the whole year and by about $3 billion for the fourth quarter of 2011.

In both of these smaller categories both noncurrent loans and leases fell but by relatively small amounts as did the loan loss allowances held by these organizations. 

The list of problem banks dropped in the fourth quarter by 31 banks to 814 commercial banks on December 31, 2011.  This total was down from 884 banks on the problem list on December 31, 2010. 

814 banks on the problem list is still a very large number representing 13 percent of the number of commercial banks insured by the FDIC.  And, this 814 banks does not included other organizations that are still in very deep trouble but do not yet qualify to be placed on the problem bank list.  The number of banks on the problem list and near being on the problem list could total about one-third of the banking system.

And, in the fourth quarter of 2011 we saw that the number of banks in the industry was still dropping at an annual rate of about 250 banks leaving the system every year.  

Bottom line: the banking system is still not very healthy.  Going further I would argue that the smaller banks are especially not “out-of-the-woods” in terms of problems.  The continuing problems being experienced in the housing market and in commercial real estate will weigh heavily on these smaller banks as we go along.  And, don’t expect much lending from them.

The largest 514 commercial banks continue to grow.  In terms of number, commercial banks with more than $1.0 billion in assets represent only about 8 percent of the organizations in the industry.  However, in terms of assets held, these larger banks hold 91 percent of the assets in the commercial banking industry and 89 percent of the loans.  Their bad assets seem to be decreasing as a problem and their loan growth appears to be getting stronger every quarter. 

Everything we see points to the continued demise of the smaller banks in the industry.  And, there appears to be nothing on the horizon to turn this trend around.