05 November 2018

Financial Times: Why deregulation ahead of a downturn is dumb

First, consider what has happened to bank share prices, particularly those of the big US banks of late. There has been plenty of commentary about the broader market slump in October. The S&P 500 index fell 7 per cent during the month. Banks such as Citigroup fared worse. Since the start of the year, all the big banks bar JPMorgan have fallen by about 10 per cent in a flat market.

Bankers are now acknowledging that the Federal Reserve rate rises, and the normalisation of monetary policy, are proving far more of a double-edged sword than they had initially reckoned. Competitive pressures are pushing banks to pass on rate rises to depositors, rather than simply magnifying their lending margins.

Second, the Fed announced its plans to lighten the capital, liquidity and stress test obligations for all but the biggest US banks. Even large lenders — those that rank just below the US’s eight globally systemically important banks (GSibs) — have been given valuable breaks, in addition to their existing exemption from the GSib requirement to issue large volumes of “TLAC” loss-absorbing capital.

This is rightly controversial. PNC, for example, is actually substantially bigger in asset terms than State Street, a GSib bank. The failure of half a dozen institutions of PNC’s size if, say, the corporate loan market collapsed and losses ate through equity capital, could be as damaging as a blow-up at JPMorgan or Bank of America. As the savings and loans crisis of the 1980s proved, even small institutions can cause chaos if they fail en masse.

Third, Kevin Stiroh, head of supervision at the New York Federal Reserve, issued a stark warning about the growing systemic risk posed by the biggest banks, as their business models converge. The most obvious example is Goldman Sachs — once focused almost exclusively on high-end corporate clients — which is now courting low-end consumers via its Marcus digital deposit and lending platform. “If firms expand, diversify and become more similar,” Mr Stiroh explained, “each might become safer individually [but] if all firms are effectively the same, they could become systemic as a herd and susceptible to the same shocks in a way that leaves the aggregate provision of financial services more volatile.”

Policymakers, of course, are themselves largely responsible for such shifts of strategy. Among the principal reasons for Goldman’s move into mass-market deposit-taking is the liquidity rule that gives preferential treatment to such funding, and the cheapness of such money, itself the result of the still-low interest rate environment. Capital rules have similarly incentivised many banks to expand into the same kinds of lending.

It all adds up to a more worrying outlook for banks than the policymakers who plotted the post-crisis clampdown intended. Sad to say, but come the downturn — and some senior figures on Wall Street are now predicting it next year — there could well be plenty to see here.

Full article on Financial Times (subscription required)

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