Bankers complain with considerable fervor about a “tsunami of new rules.” There has certainly been a flood of standards indirectly implemented by supervisors, simply demanded by the CFPB, proposed, and finalized. It’s thus understandable that bankers think they’re drowning. But, as forest fires rage in Brooklyn and much of the nation is conserving water, it’s important to recall that too little rain is also dangerous. Which brings me to the strategic hazard banks run if deregulation, while alleviating a bit of bank burden, leaves untouched all the regulatory asymmetries that make it easy for shadow banks to dominate still more profitable activities once considered core banking services. If shadow banks offer better products, so be it. However, much of their market power derives only from adroit regulatory arbitrage. That’s not just bad for banks; it’s also dangerous to financial consumers, investors, and stability.
Regulators can go only so far in easing banks’ burden because the law requires many of the rules that bind them. Nonbanks are not governed by much federal law and there are scant state safety-and-soundness standards. Tech-platform companies are outside the law unless federal regulators use their inter-connection and antitrust powers to rein them in. That these nonbanks have their eyes on core intermediation and payment services is now indisputable. That banks will end up as little more than bedraggled “partners” or ancillary-service providers to nonbanks is inevitable unless necessary bank-regulatory reform comes with long-overdue nonbank safety-and-soundness and resolution standards.
Our forecasts of financial policy under President Trump conclude that the “crypto renaissance” that brings joy across this sector poses an array of strategic risks to banks along with financial-stability and investor hazard. New industrial loan company charters allowing commercial, crypto, financial, and tech-platform firms to gain the essential benefits of a bank charter without the burden of holding-company restrictions are also a threat in more ways than one. Under new leadership inspired by the President’s crypto-nation goal, the Fed may also open the payment system.
U.S. and global bank regulators have long talked of the “same-activity, same-rule” edict that should govern financial services and infrastructure. But it’s all just talk. The results of regulatory asymmetry are obvious – see the astonishing growth of private credit as just the most recent case in point. And, while there’s nothing inherently wrong with securitization or synthetic credit risk transfers, it’s important to be clear about what these and like-kind products provide: a way for banks to do the best they can managing high-cost balance sheets by shifting ever more of the assets that once comprised their earnings. What more do prime brokers do but enable hedge funds to take risks banks can’t and maybe no one should?
Several of these services are longstanding features of U.S. financial markets, but that should not blind one to their core function: transferring most of the profits once achieved by bank products and services to others. Banks earn fees, but that’s not the same as long-term, stable interest revenue. Fee income costs a lot less in capital and other regulatory costs, but it creates a cycle in which banks each quarter have to do at least as many deals as the last quarter to bolster earnings even if the transactions pose not just strategic risk, but also long-term safety-and-soundness hazard.
Banks also need new rules because most of the old ones are not just burdensome, but also outdated and often counter-productive. I showed last week why this is true with regard to capital standards, but the same point pertains to liquidity standards as well as much in the tomes of bank-supervisory standards and examination protocols.
Despite all the celebration that the tsunami may wash back out to sea, bankers remain at grave risk. They need to get a little wet to avoid becoming competitively parched. There has never been a better opportunity for bankers to craft constructive solutions to the rules with which they wrestle and those that leave competitors unscathed. Banks won’t win all these battles, but they will lose it all if they don’t come up with sound plans for the right rules governing the right financial companies.