US election: Candidates fumble bank reform
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US election: Candidates fumble bank reform

Romney and Obama support losing banks; US falling behind Europe in the ‘non-bank bank’ sector

Mitt Romney, the Republican presidential candidate, has said that, if elected, he will revamp Dodd-Frank, eliminating parts of the regulation that are most onerous for the banks. Romney has taken particular aim at the proposals around capital requirements and trading activity. Aiming to be more supportive of the banks, he says he will reduce the power of the Consumer Financial Protection Bureau.

But, bowing to the public mood, Romney must be careful not to be seen to be backing only large banks. He has been vociferous in his claims that Dodd-Frank is damaging to community and small banks that are the engines of loans to small businesses.

Such rhetoric should be winning support for Republicans on Wall Street, but some bankers say they are left confused. "It appears that neither Democrats nor Republicans have any strategy for how the US banking sector should look," says the chief executive of a US investment bank.

President Barack Obama signed Dodd-Frank in 2010 and it was largely heralded as a poke in the eye for the large banks. It fitted with his stance that the US needed more banks and smaller banks. Yet since 2008, the largest banks have become even bigger, while many small banks have closed. According to Bloomberg, the five biggest banks’ $8.5 trillion in assets at the end of 2011 equalled 56% of the entire US economy – up from 43% just five years earlier.

At the same time, the total number of banks has decreased from about 14,000 in the 1980s to 7,240 today as many have failed or been forced to close their doors – the majority small banks with less than $500 million in deposits.

Thorns in Tarp

To boot, it seems odd that both Romney and Obama are supporting small banks when small banks are now the biggest thorn in US taxpayers’ side. All large banks have paid back Tarp (troubled asset relief programme) money received in the crisis, yet the Treasury department still owns a stake in 302 smaller banks. During the last week of August, the Treasury was forced to cancel a sale of shares held in one bank when bids fell short. Its latest auction of four banks brought in $62.4 million in proceeds, compared with an original investment of about $67.5 million.

Mitt Romney promises to repeal much of Dodd-Frank
Mitt Romney promises to repeal much of Dodd-Frank

"It is interesting that both parties seem to support small banks, yet small banks are not of benefit to the economy," says Dick Bove, senior financials analyst at Rochdale Securities. "Something like 10,000 banks have disappeared over the past 20 years in the US and yet people are saying we need more small banks. Yes, we all like the idea of the small personal bank, but at some point you have to accept that if a business model is consistently failing then it is probably past its prime." Bove says the political arguments given for supporting small banks and attacking big banks make no sense. "Small banks are not the backbone of the US economy despite what politicians claim. And big banks are not sucking the economy dry. Citi makes more money than Coca-Cola and Google. Wells Fargo makes more money than GE and IBM. Yet the corporations are highly respected, and the big banks are not."

And although Romney may be talking up repeal of much of Dodd-Frank, bankers say it is highly unlikely it will happen. For one, Wall Street does not entirely want it revoked given that much of the groundwork has now been done and priced in.

The US should be wary, however, of reduced competition when it comes to banking. Jim Barth, senior fellow at the Milken Institute, says that the US has fallen behind the times. In Europe, on the back of increased demand from consumers for greater choice in banking, retail stores have been establishing themselves in financial services. Supermarkets Tesco and Sainsbury have banks for example, and premium retailer Marks & Spencer began opening branches in its stores in July. The US, however, is one of only three countries that do not allow firms that are not predominantly financial to open banks. Walmart applied for a banking licence five years ago and was refused it because of a political backlash from community banks and unions. As part of Dodd-Frank, there is a moratorium on non-banks starting institutions insured by the Federal Deposit Insurance Corporation.

Own goals

Yet non-banks in the US have proved to be dependable and profitable. In certain states, industrial loan companies (ILCs) do exist under the brands of Toyota, BMW and Target. These total around 35 institutions. "There is so much interest from non-banks. Financial services are part of every business now, so it makes sense to finance purchases through their own bank," says George Sutton, an attorney at Jones Waldo.

Furthermore, while banks are suffering from a lack of capital, corporations are cash heavy. "They could start a bank and inject some much-needed capital back into the system," says Barth.

In terms of risk, industrial loan companies outperforming banks during the credit crisis. "When a brand is on the line and is the dominant profit centre, then the owners are going to make sure that its underlying bank will never make a bad loan or be engaged in any activity that would threaten the brand," says Sutton. They have a lower ratio of troubled assets and as a group are the most profitable banks in the nation.

"Politicians have stopped making sense in financial services," says the CFO of a US bank. "They back crowdfunding, but don’t want non-banks. They want small banks, but small banks cost the taxpayer money. They don’t like big banks, but the big banks work and have said they are happy to be reined in. Then they want to repeal regulation that controls the big banks and put the country at risk once again. It’s madness."

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