As the Dodd-Frank rulebook heads to the finish line in 2014, observers may be forgiven for thinking that the restructuring of the largest U.S. banks draws to a close with little real damage to their basic franchise. This would, though, be a grave mistake. The blizzard of complex rules may cloud the picture, but the clear strategic reality for the biggest banks is that, unless the agencies quickly change course, big banks are no longer just in business for their shareholders. Now, they’re utilities.
How do I know this? The trend has been under way for some time, especially with regard to consumer-protection standards I’ve discussed in prior memos. See, for example, the new OCC/FDIC deposit-advance rules in which banks are to figure out on customers’ behalf which products are good for them and sell only those even if the consumer is fool enough to want something else. As purveyors of consumer finance, banks are in essence to sell only broccoli even if the customer prefers Frosted Flakes.
But, an even more fundamental restructuring of the purpose of banking showed itself in the FRB’s rewrite of the 2014 CCAR. BHCs crashing to finish CCAR may have understandably added this latest stress-test requirement to their pile of year-end to-dos, but it isn’t just another quantitative “refinement.”
As discussed in FedFin’s detailed analysis, when the FRB revised the asset-growth assumptions required for stress testing in late December, it did more than tell BHCs what asset behavior it had observed in prior crises – no more assuming assets go down to make capital go up. Importantly, the FRB went beyond this methodological conclusion also to dictate a stunning requirement based as far as I can tell only on its policy predilections: BHCs now must also assume that loans go up under stress because, the Fed says, banks are always to be financial intermediaries and, thus, to roll out the loan barrel to prevent credit freezes. A BHC that might protect itself and its shareholders by eschewing loans in stress conditions in favor of, say, Treasury securities, is now to assume it will pump out the product, laying in enough capital ahead of time to be sure it can do so even under acute stress. How much does all this high-stress capital cost shareholders under ordinary market circumstances? The Fed doesn’t say, but I think it’s a lot.
In essence, the FRB has drafted banks to form a critical part of its own monetary-policy arsenal. Recognizing that quantitative easing has run its course and coming now to terms with the complexities of reversing years of accommodative actions, the FRB wants big BHCs to do what’s needed to promote economic stability even if valid business considerations would dictate otherwise. Take the term Reserve Bank, replace “B” with “b”, and you’ve got the picture – big BHCs must promote financial intermediation to support national objectives even if their own profit needs dictate otherwise.
What’s next? In an array of rules designed to prevent “negative externalities,” the FRB is essentially crafting a framework in which big BHCs are redesigned so that, like utilities, the lights stay on in all but the most extreme disasters. Costly though this is, the institutions must pay up to promote the public good even if their private charters are shredded along the way. Has the industry thought this through and decided on the balance it wants between profit and purpose? Not so far, meaning big BHCs may only realize how different they are after the new paradigm is fully in place and it can’t be undone.