Inside Financial Services

For The Sake Of The System, Banks Should Be More Profitable

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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!

15 Responses to “For The Sake Of The System, Banks Should Be More Profitable”

  1. Avatar SWPilgrim

    In effect, TBTF banks are the newest public utilities. The only access to double-digit capital returns will be via scale, opportunistic pricing and surgical efficiency which has yet to be acheived. CEOs will need to shoulder compliance management rather than delegate acquiesence and be better grounded in operations systems and technology. Definitely a next generation issue for those who limp through on the investment banking/trading carried over from the last decade. Not likely to be a fun undertaking.

  2. Avatar Morgan's Mom

    I’m no banker but I’m wondering, is this the path to income equality?????? Keep investors potential profits as low as possible???????

    • Avatar Allan S.

      Morgan, did you think it was the path to income equality when bank CEO’s and board members raked in untold wealth at the expense of the middle class? If you were supporting a family on $100,000 a year, many people do you know, you might take exception to your comment. I can’t think of a better way to destroy capitalism than to keep screwing the middle class in an effort to enrich the bank CEO’s of the world.

      • Avatar Morgan's Mom

        Allan, like I said I’m no banker and not a member of the 1%. I work hard and do not like CEO’s unduly enriching themselves, but sometimes I wonder if the medicine created by government isn’t part of a bigger picture, ultimately trying to keep the frog in the pot by turning the temp up just a little at a time. Soon you can’t hop out.

        In a perfect world the boards should police the business, but I’m sure they work just like local boards do, i.e. school boards, hospital boards, etc. I know around here they work hard to get the people in that will say yes. Oversight is not really oversight when that happens. Then the county hospital CEO can hire an independent firm to study any pending projects the hospital wants to pay for with the taxpayer’s money. Guess what the firm will deem it all good and necessary. Lo and behold if the project fails guess who gets the blame, why that independent firm that was hired for the study! Genius CYA work going on all the time.

  3. Avatar PureDakota

    The Dodd Frank formula: (1) Increase capital requirements, (2) Add significant cost, and (3) Remove opportunities to generate income. How ingenious!

  4. Avatar Anonymous

    You have to pass it to know whats in it Nancy Polosi what drugs does she do

  5. Avatar Allan S.

    Have we bankers forgotten we brought Dodd-Frank on ourselves?
    Have we forgotten the executives who orchestrated that great debacle kept their bonuses and never saw jail time?
    I don’t think think crying about Dodd-Frank and less profits will generate much sympathy.

  6. Avatar PureDakota

    This is not about sympathy. It is about where capital flows. It flows to perceived opportunity. For rational people with money to invest, sympathy is not a consideration.

    • Avatar Allan S.

      Pure, where were you rational people when capital was flowing the wrong way? The American people are in no mood to hear from greed merchants about their damn capital. Have you forgotten the capital in play today was a gift from beleaguered middle class tax payers?
      You guys are capitalist until you’re not.

  7. Avatar Friend of the CFPB

    The reality is banks are less profitable. What has been forgotten is how much risks bank executives took when profit potential was greater. Then when it did not work out they walked away wealthy. Laws were created to stem abuses and you need not look any farther than former management to see the route cause and need for changes.

  8. Avatar PureDakota

    Allan, I am as bugged as you are over anyone who filled their pockets at the expense of the taxpayers and their companys’ shareholders. By the way, didn’t the US Government made money on its TARP program? It was bailing out FNMA/FHLMC that cost the big money. Yet the biggest cost was a loss of faith in the system; and banks, even good, well-managed ones, will be bearing the cost of that for some time. My comments were only intended to say that solutions need to be less about punishing the banks, and more about finding solutions that will work, those that are based on solid, realistic and careful analysis, and not on emotion.

    • Avatar Allan S.

      Pure, I don’t totally disagree with you. But now we know what the smartest people in the room are capable of doing to fulfill their sense of greed. Perhaps regs could be changed, but what ever the regs, there can be no opportunity to screw the pooch much less then retire to the Hamptons. This Wall Street mantra of the “profits are private and the losses are public” just can’t be repeated. It’s that type behavior that jeopardizes capitalism.

  9. Avatar Anonymous

    Ultimately, Dodd-Frank and excessive government regulation will drive capital out of the banking system. Low ROE’s won’t attract capital. The utility analogy is generally correct except that at least utilities enjoy some monopoly advantages that banks won’t have. It might be that the lack of profitability of banks will parallel what will happen to the health insurance industry with ObamaCare’s bad underwriting dictates bankrupting the industry, leaving no private industry. That’s the game plan for health care insurance. Is that the end game for banks too? Dave B.

  10. Avatar Allan S.

    If it takes bad underwriting to get rid of the inefficient healthcare insurance companies, then three cheers for that. The insurance companies had their chance to advance healthcare in the country and they blew it. Greed is good, right?

    The government already has a great healthcare system and it’s called Medicare; just expand the program to cover everyone and utilize income based premiums. Something does need to be figured out about ridding the emergency rooms of scofflaws.

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