Sizing up the state of the banking industry in the aftermath of Dodd-Frank, The New Yorker’s James Surowiecki makes this observation:
Profit-making opportunities for banks have also shrunk. Thanks in part to the new capital requirements and to new rules curbing banks’ proprietary trading, fixed-income trading has dried up, costing banks billions of dollars in revenue. Dodd-Frank has also reduced the middleman fees that banks collect—for instance, by moving much of the trading of derivatives onto the open market. More than half of credit-default swaps and seventy per cent of currency swaps now trade through a public clearinghouse. (Before the crisis, only a small percentage did.) Until recently, big banks were able to borrow money much more cheaply than small ones, because investors assumed they’d be bailed out in a crisis. But recent studies suggest that that funding advantage has nearly disappeared. [Emph. added.]
Surowiecki seems indifferent to the fact that the banking industry is inherently less profitable than it used to be, and I’m not sure why. One of the best ways to assure that the financial system stays strong and stable, after all, is to assure that the institutions within it be broadly and strongly profitable. They can more quickly build their capital cushions that way, and more easily attract outside capital when needed. But that’s not what the post-Dodd-Frank banking system looks like. Pre-Dodd-Frank, banks earned 13% on their equity on average. Lately by, contrast, industry ROEs run in the 9% range—below, I would note, what many investors consider their cost of capital. What’s more, the breadth of profitability is lower now than it used to be, too, as policymakers have effectively forced banks to exit certain businesses (market-making, for instance) and prohibited them from charging reasonable fees in areas like credit and debit cards. No wonder analysts are starting to wonder out loud about the basic business models of one-time Wall Street titans.
In any event, while Dodd-Frank has strengthened the banking industry by insisting on stronger capital and liquidity, it has weakened it by sapping banks’ inherent ability to make money. The result is that when the next financial crisis hits—and it will, as we all know–the banks won’t be in as strong a position to endure it. Policymakers and bank critics apparently think this is a good thing. I’m at a loss to understand why.
What do you think? Let me know!