|More on the Volcker rule|
Bank profits will take another hit, while a wave of job losses are likely to hit Wall Street, if the Volcker rule written by four regulatory agencies and published on Tuesday is implemented, experts claim.
It is also suggested that, consequentially, growth in the financial sector will slow and lead to another round of capital injections for banks, especially in Europe.
The implication for adopting the Volcker plan is that it will cost those investment banks or those with investment banking divisions 25% of their profits in the years ahead, says David Buik, partner at BGC Partners. We only remember the bad times and we fail to appreciate the enormous contribution investment banking has contributed to growth. Growth will take a knock and the financial sector could find itself in the doldrums for some months. The strain on the taxpayer in Europe to recapitalise the banks could prove to be very painful indeed.
The 298-page proposed rule, which was issued on Tuesday for public comment, would ban banks from trading for their own accounts, with only the ability to make short-term trades for hedging or for market making. Banks would also face a limit on investments in hedge funds and private equity funds.
[The Volcker rule] implies that banks will have fewer higher margin profit opportunities and equally should reduce risk and that they will be less committed to market making, says Marc Ostwald, market strategist at Monument Securities.
The Federal Reserve, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency worked with the Securities and Exchange Commission on the Volcker rule, which is to vote on introducing the rule today.
However, since the proposed rule has been issued for public comment, there are many unanswered questions surrounding precise definitions for the many banned activities.
One part of the ruling that some banks are preparing for is the dissolving of prop trading desks, which will lead to a number of job losses across the sector.
On Wall Street in particular, it is estimated that the securities industry could lose nearly 10,000 additional jobs by the end of 2012, which would bring total industry job losses to 32,000 since January 2008. This is according to an annual report on the securities industry released on Tuesday by New York State Comptroller Thomas DiNapoli.
The securities industry had a strong start to 2011, but its prospects have cooled considerably for the second half of this year, says DiNapoli. It now seems likely that profits will fall sharply, job losses will continue and bonuses will be smaller than last year. These developments will have a rippling effect through the economy and adversely impact State and City tax collections.
DiNapolis analysis also revealed that job losses are likely to continue, given declines in profitability and recent layoff announcements. After adding 9,900 jobs between January 2010 and April 2011, the securities industry has lost 4,100 jobs through August 2011.
Excessive risk-taking on Wall Street was a major factor leading to the financial crisis and the recession, says DiNapoli. Regulatory changes that reduce risk and focus attention on long-term profitability rather than short-term gains will enhance stability. Despite the weaknesses we are seeing, the securities industry remains profitable and is a key component of the economies of New York City and New York State.
However, some market experts believe that the bank dissolvement of prop trading desks will help the financial sector, minimise risk and build a more stable trading environment.
Proprietary trading activities, where it has gone beyond what the normal conduct of investment banking business requires, have in the past only ever temporarily helped to improve banks earnings, says Lothar Mentel, chief investment officer at Octopus Investments.
But they have always introduced significant earnings volatility and when not kept in check brought down [Barings] or impaired banks [Société Générale, UBS] when rogue traders risked and lost billions.
There are now enough hedge funds and private traders around to fulfil the liquidity provision and market efficiency mechanisms that prop desks can be argued to contribute positively to the financial system. Therefore, the risk they introduce to investment banks is no longer justified by these market benefits.