Can Trump Stop the Global Banking Squeeze?

by Robert Kramer

A look at the impact of the financial crisis on U.S. (and foreign) bank profitability and the cost of additional regulations provoked by the financial crisis.


An oft repeated lament heard from U.S. corporate treasurers is that the universe of sophisticated global banks has shrunk significantly since the Great Recession. This has had serious impacts on multinational corporations wishing to perform treasury functions internationally, such as cash management, foreign exchange, hedging, direct foreign investment, mergers and acquisitions and credit-financed tax arbitrage.

The loss of competition has increased the cost of these services, while providing fewer choices to U.S. treasurers wishing to bank with U.S.-based global institutions.  This trend has arisen largely from two related effects: the impact of the financial crisis on U.S. (and foreign) bank profitability and the cost of additional regulations provoked by the financial crisis, including the regulations implementing the Dodd–Frank Wall Street Reform and Consumer Protection Act.

The very largest global banks have suffered the most from governments’ reactions to the financial crisis. Even over the last year, for example, Deutsche Bank’s share price has tumbled 62.2 percent largely in response to U.S. government actions.  Since the Great Recession, Deutsche Bank has been buffeted by a series of regulatory missteps; resulting in $9 billion in fines and settlements. These included manipulating precious metal prices, defrauding mortgage companies, colluding with other banks in the LIBOR scandal, and involvement in various transnational financial transfer schemes.

In the wake of these challenges, both Co-CEOs of Deutsche Bank resigned and the bank is in the process of restructuring (a so-called bail-in strategy whereby the institution sheds assets in lieu of a government bail-out). In addition, it has focused its capital market activities on derivatives, and has pulled back from its once dominant investment banking role.   In June, the International Monetary Fund awarded Deutsche Bank the dubious distinction of being “the most important net contributor to systemic risks” in the global market.

Deutsche Bank is only the latest of the integrated global financial institutions, sometimes known as universal banks, to experience both market and regulatory risks that required structural responses.  Hit hard during the great recession, the largest U.S. and EU banks hunkered down, pulled back lending and investment activities and began divesting unprofitable business units.  Citibank, for example, sold or closed retail operations in more than 50 percent of countries in which it had a presence (including Japan).  It reduced the number of U.S. branches by two-thirds (more than 1,300 branches), and pulled out of life insurance, student loans and sub-prime lending.  In doing so, it relinquished 25 percent of its customers (69 million) and cut 40 percent of its workforce.

Like Citi, Hong Kong Shanghai Banking Corp. (HSBC) retreated from retail operations in 50 percent of the countries where it had such operations, while dropping about 80 million customers.  It also closed 1,600 U.S. locations and more than 500 branches in the UK, its home base. Like Citi, it flipped the majority source of profitability from retail to corporate and investment banking.  Barclay’s and Royal Bank of Scotland have also divested foreign and/or domestic businesses.

On top of this, regulators have imposed additional capital requirements, stress testing and resolution planning on so-called systemically important financial institutions (SIFIs).

Despite significant cost cutting and divestment measures since the Great Recession, return on equity remains in the single digits for many of these institutions.  In 2014, global ROE had stabilized at 9.5 percent, but much of this was the result of significant growth among Chinese and Latin American banks, while European banks have still not recovered to 2007 levels.  Globally, about 60 percent of 2014’s trillion dollars in bank profits was accounted for by very large banks.

What is perhaps most remarkable, despite continuous increases in operational efficiency, divestiture of poorly performing assets, significantly higher capital and leverage ratios, and greater regulatory controls, banks, especially large global banks have shown an increase in perceived market risk.  A Brookings study by Lawrence Summers and Natasha Sarin, suggested that financial market information provides little support for the view that “major institutions are significantly safer than they were before the crisis and some support for the notion that risks have actually increased”.

The study concludes “that financial markets may have underestimated risk prior to the crisis and that there may have been significant distortions in measures of regulatory capital. … [W]e believe that our findings are most consistent with a dramatic decline in the franchise value of major financial institutions, caused at least in part by new regulations. This decline in franchise value makes financial institutions more vulnerable to adverse shocks (emphasis added).”

In the days immediately following the election, shares of the largest U.S. banks spurted to new highs for the year on the news of a Trump victory, largely based on Trump’s often repeated intention to “mostly” repeal Dodd-Frank.  This and his pledge to reduce regulations and countermand the Obama Administration’s numerous executive orders have given investors hope that the financial sector would prosper under the Trump presidency.  Surprisingly, not much was said about the Republican platform’s goal of resurrecting Glass-Steagall.

While the financial sector generally may hope to benefit from a Trump Administration’s actions to repeal Dodd-Frank and curtail regulations promulgated by the last Administration, the re-imposition of Glass-Steagall on the banking industry would further challenge the viability of large global banking institutions – or would it?

Glass-Steagall largely prevented Federal Reserve member banks from: dealing in securities for customers; investing in non-investment grade securities for themselves, underwriting or distributing non-governmental securities and affiliating with companies involved in such activities.  The bill also prohibited securities firms and investment banks from deposit taking.  In 1956, Congress passed the Bank Holding Company Act which limited banks involvement in the insurance business as well.  The Trump campaign indicated that it was against Dodd-Frank’s Volker amendment which limits securities activities undertaken by banks on their own behalf.  Consequently, an important aspect of Glass-Steagall may not appear in the new bill.

In addition, there were several "loopholes" that financial firms and sympathetic regulators were able to exploit during the lifetime of Glass–Steagall restrictions. Savings and loans and state-chartered banks (not part of the Federal Reserve System) were not covered by Glass–Steagall, and securities firms were also not prevented from owning such institutions. In addition, while Federal Reserve member bank could not buy, sell, underwrite, or deal in any security except as specifically permitted by Section 16, such banks could affiliate with a company as long as it was not "engaged principally" in such activities. By 1998, the year that Citicorp and The Travelers Insurance Co. merged, many large banks had utilized the affiliates’ provisions to reengage in the securities business.  The passage of GLB made operating a universal bank much easier, but many of GSA’s restrictions had already been legally circumvented.

So, it is reasonable to expect that even if President Trump enacts new Glass-Steagall -like legislation, it will not have the dilatory impact on global banking institutions that many presume. However, it is also reasonable to conclude that even if Dodd-Frank is repealed, large global banks will continue to lose market share to more nimble Fintech and non-bank (less regulated) financial industry competitors, while struggling to meet the looming capital and leverage requirements of Basel III.  Indeed, Trump’s promised regulatory relief may be a day late and a dollar short, from the standpoint of these industry giants.