Global banking regulation needs urgent harmonization and US banks cannot afford to pull back from Europe in spite of Brexit. These are two conclusions from a discussion in Washington between the CEOs of Citi, JPMorgan and Morgan Stanley, held during October’s annual meeting of the Institute of International Finance (IIF).
Can the banking sector finally see past the regulatory process that has been in place for the last seven years, moderator Tim Adams, head of the IIF, asks.
Morgan Stanley’s James Gorman cannot. “I’m sighing. Wow. No is the short answer,” he says. The banking system is dramatically better capitalized than it has been, and the amount of regulatory change in the last five years is equivalent to the previous 50, he adds. “Unfortunately many of the jurisdictions around the world are now operating at different paces. We have more belts and suspenders, but the lack of harmony is the next phase of the problem.
“We’ve got to step back and look at the cumulative impact of what has taken place, between the changes in liquidity, the changes in capital, the annual health tests, and then at the back end, a resolution plan to make sure you don’t mess up the neighbourhood if things go under. We need to start digesting some of this.”
Citi’s Mike Corbat worries about whether Basel III will break down because of the lack of a level playing field. “It does for the first time feel like there is a real divergence emerging, with different constraints in the US to what Europe has today,” he says. “That starts to get to a dangerous place when customers and clients try to do comparisons around safety and soundness.”
He certainly does not think the US is skimping on its supervision of big banks, though, agreeing with Adams that Citi’s CCAR submission probably ran to somewhere in the region of 22,000 pages. Gorman thinks that sounds more like the executive summary.
For JPMorgan’s Jamie Dimon, what matters is making sure that regulation is actually helping the economy, and here he feels European banks are bearing a tough burden. “I believe, out of sympathy for the European banks, they’ve been deleveraging and catching up for seven years, let them stop, digest it, and finance the economy,” he says. “And it’s really important for Europe, where 70% of the economy is financed by banks, not the capital markets.”
If he could change one thing about banking regulation, it would be the capital needed to be set aside for reserves at central banks and related to operational risk. “Because of that you have IRS [interest rate swaps] going negative, you have basis problems, you have the repo problems. Someone is going to look at that one day and say: ‘Why do you have all that capital?’,” he says.
Gorman does not want to get into which bits need changing – for him it is enough to acknowledge that they would all want to change those pieces most harmful to their businesses. “The financial system is much safer than it was, returns are demonstrably lower because it carries much more capital and it behoves all of us to change our business models,” he says.
Adams wonders if, with banks so much better capitalized, there isn’t some scope for US banks to play a consolidation game in Europe. Gorman gives that short shrift. “There is planet Earth and there’s planet somewhere else where Tim is sitting,” he says. “I don’t think there is much enthusiasm for banks getting bigger right now.”
That said, he notes that the facts on the ground have not supported the view that there is a regulatory perception that big is bad. “If you look at the balance sheets of some of the largest banks in the world, they’re bigger than they were pre-crisis,” he says. “If you’ve got a global economy that is growing, then the banking and financial sector will grow. It grows with GDP. Big is not bad: it’s how they are managed and whether regulators are attaching the right amount of capital to the businesses you choose to be in. “The question of absolute size is only political rhetoric, not regulatory rhetoric.”
New York the Brexit winner
The three CEOs do not downplay the significance of the result of the June 23 referendum in which 51.9% of UK voters opted to leave the European Union. But they are staunch in their belief that it did not, and should not, affect the attraction of Europe as a destination for US banks.
Corbat thinks something new is happening and being reflected in voting processes around the world. He cites the Brexit vote on the UK’s membership of the EU, the surprising rejection by the Colombian people of a peace agreement between the government and rebels, and the tone of the US election campaign.
“What we are seeing is rather than people voting for things, people are voting against things,” Corbat says. He argues that the trend makes the results – and their consequences – much more difficult to predict. The negativism stirred up by populism would weigh on an economy, he says. “When you surprise a population around these votes, it undermines confidence and the willingness to spend.”
Dimon, unsurprisingly, conveys mostly breezy optimism. Is Brexit his biggest worry? No. “It will reduce the GDP of the UK; that’s not a disaster. It will create years of uncertainty; that’s not a disaster,” he says, adding that his industry will find what it needs to do within the new rules.
For him Brexit is about something much bigger. “Brexit was always about the survival of the eurozone,” he says. Here he is pessimistic: the vote has made the chance of the eurozone not surviving the next 10 years some five times higher than before.
Gorman agrees that what is at stake is the survival of a system that has been in place for 70 years and has been a success, notwithstanding challenges such as coping with immigration. But somewhere along the line, the positive message has been lost in a narrow discussion of those challenges that tap a vein in countries like Spain, Italy and other parts of the EU.
As far as the impact on his firm, he says that “we care about the 25-year-old, the 27-year-old, in our office in London, who hasn’t been in the UK for five years. What happens to them? Do they get residency?” And it is not just the effect on individuals.
Occupying his mind is the question of how banks deal with moving parts of their business into different markets, and how this imposes other needs such as moving control, compliance and audit functions. Do other cities have the necessary infrastructure in accounting, legal and banking capabilities that a firm needs to make that kind of move?
Gorman is certain on one thing: “I think the big winner will be New York and the US”, not by design but as a result of the various potential outcomes.
That said, his hope is that discussions will progress in such a way as to continue to encourage London, which has benefited from good regulation, good rule of law and an entire ecosystem that has grown up around the financial sector.
Has Brexit changed any of their views on whether their banks still want to be playing in Europe? All three are adamant. “Europe is an $18 trillion economy,” says Gorman.
“It’s not a question of: ‘Are you interested in being there’.” And parts of Europe are doing well, he notes, citing Germany and the north-east, as well as economic miracles in Eastern Europe. “Europe remains a critical part of running a global financial institution.”
Corbat, who runs a firm that has pipes connected to 20 of the 27 EU countries that will remain after the UK’s exit, says that it was “not a question of being there, just how you would be there”.
Dimon certainly has a head for risk, but he doesn’t see much point in endless discussions about it: he says he likes to cut risk committee meetings off after an hour because if they go on too long they tend to result in not taking any risk.
He muses that someone pitching to a risk committee about the merits of investing in the US after a trip there in 1865 might have come across plenty of objections.
That does not mean he doesn’t see problems: a country leaving the eurozone is a real issue, as is dealing with the complexity that it will create. But at the end of the day, “the world is going to be OK”, he says. Thank goodness.