We ask this question because it matters, not just to banks but to the entire U.S. economy. We need a healthy banking system for the economy to thrive. But banks are in a bind. On the one hand, we have the “fintech” upstarts who are making inroads into consumer lending and wealth management, to name two areas. They are disrupting traditional business models. On the other hand, we have banking regulators, who, in the wake of the financial crisis, have really clamped down on banks.
What has that done to financial institutions? They are well-capitalized and safe, yes, with tons of shareholders’ equity. But it also means their return on equity is very low, much lower than before the crisis. But regulation goes beyond that, because liquidity, and where it lies in the banking holding company structure, is also a focus of regulators. When high liquidity is necessary within particular businesses, banks take a hit on their investment returns.
Those two effects of banking regulation affect a third party: equity investors. Shareholders, banks will tell you, are getting impatient with the moribund returns of publicly held banks. They’re asking a key question, for them: What’s going to change the earnings outlook for bank stocks?
This is also an important question for federal regulators. At a recent Fitch Ratings banking conference, the topic of regulator expectations’ of bank profitability came up. What do regulators consider is an acceptable or healthy level of profitability for a bank? There wasn’t a good answer, but a regulatory representative did say regulators want to make sure banking companies are viable and long lasting, and that they have a reasonable cost of capital.
Is post-crisis regulation strangling banks and actually hurting their viability as businesses? If it is, that would seem to be a sign of overregulation. We don’t have the answer, but the experts in this edition of Square-Off have some opinions on the matter.