Regulation May Be A Threat To Banking

See Future of Banking Looks Dark—Why That’s a Problem: Institutions’ sagging profitability poses wider threats to economic growth by Greg Ip of the WSJ. Excerpts:

"The point is illustrated well by a recent study by Natasha Sarin and former Treasury Secretary Larry Summers, both of Harvard University, and presented at the Brookings Institution. They decided to assess the stability of banks not as regulators do, which usually means looking at capital (such as shareholders’ equity), but as markets do. They examined the behavior of common shares, preferred shares, options, credit default swaps and various valuation yardsticks.

They discovered that markets think banks are much more likely now to lose half their market value than before the crisis. They interpret this as a “decline in the franchise value of major financial institutions, caused at least in part by new regulations.” The counterintuitive implication: The bevy of rules designed to make banking safer may, by endangering their long-term viability, ultimately achieve the opposite."

"Regulation is part of the reason. To better buffer loan losses, banks must now hold more capital such as shareholders’ equity, which spreads​profits across more shares. To deal with sudden outflows of funds, they must hold more highly liquid short-term assets, such as Treasury bills, which earn less than loans.

This has been compounded by the sluggish economy, which has held back loan growth, and by monetary policy. Banks profit from the spread between the interest they charge on loans and pay to depositors. But loan rates have been pulled down as central banks hold short-term rates at or below zero and buy bonds, and banks are reluctant to pass that on to depositors by charging to hold their money. Moreover, when central banks buy bonds, they pay with newly created cash that sits on banks’ balance sheets earning nothing, or less."