Inside Financial Services

Another Unintended Consequence Of New Banking Rules

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From yesterday’s Wall Street Journal:

 

Banks are urging some of their largest customers in the U.S. to take their cash elsewhere or be slapped with fees, citing new regulations that make it onerous for them to hold certain deposits.

 

The banks, including J.P. Morgan Chase & Co., Citigroup Inc., HSBC Holdings PLC, Deutsche Bank AG and Bank of America Corp. , have spoken privately with clients in recent months to tell them that the new regulations are making some deposits less profitable, according to people familiar with the conversations. [Emph. added]

 

Once again, all hail the wisdom of bank regulation! In this case, onerous new liquidity rules set to take effect on Jan. 1 will render large, uninsured institutional deposits unprofitable for large banks, absent new fees. So clients are mulling whether to pay those fees or (as they’re apparently being urged by some banks) pull their money altogether and park it with a non-regulated shadow banking institution such as a money manager. The result: many billions in financial assets will likely be leaving the (highly regulated) bank system for the less-regulated shadow banking system, invariably referred to as the “Wild West” by financial editorialists and frustrated bank regulators.

 

Well, what did they expect would happen? This sure isn’t the first instance of a new regulation having the very opposite effect it was intended to have. This time around, rules meant to boost banks’ stability and liquidity will actually have the effect of making the financial system less stable. The added risk isn’t just theoretical, by the way. Recall that it was a run on money market funds—precisely the sort of non-bank alternative big banking customers are likely considering as alternatives for their cash–that sparked the liquidity crunch following the Lehman bankruptcy. A major new influx of cash into money funds would presumably increase the odds of a similar run sometime in the future. How’s that supposed to help?

 

This is just the latest example of an effect the federal government’s Office of Financial Research pointed out last week: the recent re-regulation of the financial system has made the system less stable, rather than more so. This is in large part because (as with big institutional deposits) in many cases new rules are so burdensome they are driving financial activities out of the banking system altogether.

 

The financial system needs to be regulated. But when banking rules become too intrusive or expensive to carry out, they become worse than useless. In the wake of Dodd-Frank that’s exactly what we’re seeing happen.

 

What do you think? Let me know!

3 Responses to “Another Unintended Consequence Of New Banking Rules”

  1. Avatar Ole Holsti

    What we really need is for a bunch of top bank executives to get 5 to 10 year sentences, like Madoff’s colleagues. That will do more than anything to keep the banksters of the future on the straight and narrow.

  2. Avatar JimBob

    Brilliant idea Holsti. Way to address the issues. If you think they are guilty, why hasn’t the famous Attorney General done it already? But back to reality. When at the end of the day, you find the existing system bloated by regulation and the money moving to shadow banking, or offshore to a foreign country, do you a) write more regulations to gum up the system or b) try to find a plausible solution that ensures substantial oversight, without micromanaging a major part of the global economy? I know the answer is (a) currently, but eventually, the regulators will realize there’s nothing left to regulate, which will most likely come after the next market crash.

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