Next Thursday, I will present a paper on the strategic and policy implications of the shift to shadow banking at the Federal Reserve Bank of Chicago’s annual competition conference. My goal is to lay out not just the policy questions raised by the rapid realignment of even the most traditional financial-intermediation services, but also the banker’s “beat them or join them” dilemma. Can strategic decisions await finalization of all of the rules or the next board retreat somewhere nice? I don’t think so.
Time isn’t on the banker’s side — the paper I finished yesterday anticipates private-equity activity in corporate banking. Today’s New York Times http://dealbook.nytimes.com/2014/05/01/k-k-r-seeks-to-attract-investments-as-small-as-10000/?_php=true&_type=blogs&_r=0 features an announcement that KKR has joined Carlyle in launching a major new venture gathering funds to make loans – that is, banking. The FT this morning notes that hedge funds have gotten so tired of waiting for a new CMBS market to open that they’ve decided to become commercial real estate lenders all by their not-so-little selves. The Wall Street Journal http://online.wsj.com/news/articles/SB10001424052702304163604579531734050929794?mg=reno64-ws today features an assessment of the shift of overall real estate lending from banks to non-banks. A Reuters wire http://www.reuters.com/article/2014/05/02/regulations-summit-mobilephone-idUSL6N0NN19U20140502 looks at mobile-payment services and concludes that retail banking is in a whole new framework. Hearing jungle drums yet?
Is it wrong that KKR, Carlyle, Google, PayPal, and so many others are cherry-picking the most profitable businesses long housed in banks? Of course not – they have a right to innovate and do so not just with technological craft, but also with regulatory acumen. One thing all of these companies are very good at is decisive action; one thing that bankers and their regulators are very bad at is, yes, decisive action. As regulators issue advance notices of proposed rulemaking and bankers marshal their comment-letter writing resources, non-banks forecast the resulting landscape, pick targets of opportunity, and move.
One more story from today’s papers: Reuters features remarks from David Wright, the head of the International Organization of Securities Commissions. He says that he is worried by the rapid realignment of what once was banking into what may or may not be securities or asset management. He also says, though, that he isn’t sure how to define these parameters or what to do about them. The Financial Stability Board plans another session with its usual due deliberation in November at the next G-20 to report on what’s been done to date on equilibrating financial regulation, but I would guess Mr. Wright’s comments epitomize the FSB’s workstreams. Some new SIFIs may be designated and a bit more done on universal margins for repurchase agreements, but the fundamental shift of finance from bank intermediation to non-bank products and services will accelerate not just because the shadow rules are slow, but also because all the new banking rules are tough.
From this, what’s a banker to do? First, I think it’s critical to determine where shadow firms win by virtue of acumen and where they gain edge principally through regulatory arbitrage. Where they win because they’re good at the game, more power to them. Where they win due to regulatory arbitrage, we need to go a step further and assess whether non-banks have a regulatory edge because they don’t get bank-only benefits like deposit insurance or central-bank access. If the regulatory advantage is offset by limited taxpayer backstops, then again the non-banks should be allowed to go for it unless – a big unless – systemic risk might result. But, when regulatory advantage comes in concert with access to taxpayer benefits once the sole prerogative of regulated banks, then an urgent policy realignment to level the proverbial playing field must begin.
Bankers can and should advocate for this, but they can’t wait for it to happen. The day-in, day-out redefinition of their most profitable businesses requires them to do disciplined strategic analytics, line of business by line of business. The FRB-Chicago paper outlines considerations here, as well as critical regulatory drivers in selected business lines. Where bank-only rules are not outweighed by bank-only benefits, a business line is a loser. Maybe not now, but surely soon unless the rules change or the bank redesigns its franchise.