And still, bankers don’t get it.
The banking industry’s first response to the Obama administration’s so-called plan for bank regulation misses the point. It can decry all it likes Obama’s flip-flop towards restricting the scope and size of banks as electioneering and not a serious legislative proposal. It can scoff that the plan will falter before Congressional opposition, as the technical difficulty of defining proprietary trading becomes clear.
The industry doesn’t seem to realize how few friends it has, or that any politician hoping for re-election could not take the banks’ side.
It is too early to assess what final form the Volcker rules will take or their impact on banks’ earnings and capital generation. Many senior bankers privately express horror and outrage but their own analysts take a more sober view, pointing out that earnings from prop trading have shrunk in the past two years anyway, as banks concentrated on customer flow. Banks that made up to 20% of their earnings from prop trading in 2006 and early 2007 now derive maybe 5%.
Hiving off private equity and hedge funds would reduce bank earnings but the disposals might help banks rebuild their capital and investors might put a higher multiple on less risky and volatile remaining earnings.
If the rules are copied in Europe, analysts at KBW suggest that the value destroyed would be from 6% to 8% at European investment banks such as Deutsche, UBS and Credit Suisse to 2% to 4% for universal wholesale banks.
For all that, Obama’s move is hugely significant. Exactly the type of structural changes the banks feared in the spring of 2009 – and then thought they had side-stepped as strong earnings enabled them to repay government support – will now be imposed. The debate has moved decisively beyond how to tweak capital requirements against market risk and whether or not to impose leverage ratios.
This is an attack not on particular activities but on the whole culture of modern banking. Mervyn King, governor of the Bank of England, quickly picked up on this, as he endorsed the spirit of the Obama plan to UK members of parliament, while reviving discussion of another structural change the banks hoped they had buried: the requirement for separate capitalization of local subsidiaries in each country.
In reality, there were no good or bad business models that helped banks survive the crisis or condemned them to failure. There were only good or bad management teams, and good and bad regulators.
But the fight to prevent wholesale structural changes being imposed is one the banks are losing. Perhaps it is a fight they must lose.
Yes, diversified earnings from trading, including prop trading and hedge-fund-style investing, have helped many universal banks that would have shown losses on retail banking operations in 2009 to turn a profit.
Yes, those pools of capital add much-needed liquidity to financing markets on which businesses increasingly depend. But banks must do a much better job of arguing that they should retain these earnings streams in house if they are to convince those that now conclude they have only been used to enrich reckless individuals – who clearly failed to understand many of the market risks they were taking – who funded their bets on the basis of implicit sovereign guarantee.
The chief downside to the sudden promulgation of the Volcker rules is that it exposes the absence of proper international coordination of new regulation of a global industry whose fate is so closely tied to that of the global economy. This spreads uncertainty in banks that requires confidence simply in order to function.
William Rhodes, senior vice-chairman of Citigroup and first vice-chairman of the Institute of International Finance, complains that: “Actions by governments to take unilateral measures… will damage the financial system. The G20 has stated in its summit declarations an acute awareness of this risk, yet almost every day now we are seeing policy decisions and announcements that are not being coordinated and that have the potential of doing systemic damage.”
But a common approach was always a vain hope. Sovereign states with damaged banking systems were always going to tailor their regulatory responses to their own circumstances.
If banks want to wrest back the argument, they must do so by coherent analysis of the economic impact of regulatory change. Would the Volcker rules, if enacted, impede the supply of credit and capital to productive users? It’s the one question that needs answering most urgently.
