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 In interviews with Reuters, six senior bankers said they are
struggling with the costs and restrictions they face as a result of
new regulations, as well as a weak global economy and troubled
financial markets. The bankers, who are or recently were in
positions ranging from business division head to CEO, spoke on the
condition of anonymity so they could be candid without upsetting
regulators or investors.
"Fundamentally, the business has to change," said one veteran banker
who was on the executive committee of a major European bank until
recently. Big banks' shareholder returns have sunk "too low," he
said.
These problems are not new, but they have fresh relevance as
Deutsche Bank AG confronts questions about its capital
adequacy, Barclays PLC faces pressure to break up and CEOs of big
U.S. banks struggle with a loss of investor confidence in their
stocks.
(For a graphic of U.S. banks' price-to-book ratios, see http://reut.rs/1SG0NDL)
Management teams in the U.S. and Europe are now taking a hard look
at dramatic business model changes, but none of the options are
particularly attractive, the bankers said.
Merging to cut costs and improve margins is out of the question,
given the hurdles banks would likely face from regulators who do not
want "too-big-to-fail" institutions getting any bigger. Splitting
apart is complicated by capital requirements that would make
standalone trading businesses economically unfeasible — and by the
fact that there are few, if any, buyers for the assets banks want
least.
Some top bankers say they are left with little choice but to muddle
through what they fear will be a long, dark period of weak earnings,
angry shareholders and gradual shrinkage.
The problem has gotten so bad that Deutsche Bank CEO John Cryan
recently said on a public conference call that he'd much rather be
CEO of a simpler, retail-focused bank like Wells Fargo & Co <WFC.N>,
which has only a modest investment banking operation.
"Unfortunately," he said, "there are lots of things I wish for that
are not going to come true."
RATCHETING UP CAPITAL
Kashkari's comments, in his first speech as head of the Minneapolis
Fed, were surprising because he is a former Goldman Sachs banker, a
Republican, and was a senior Treasury official in President George
W. Bush's administration during the financial crisis.
They partly echoed the stance of Bernie Sanders, who has also called
for big bank breakups and criticized Hillary Clinton, his rival in
the struggle to be the Democratic presidential candidate, for being
too close to Wall Street. Some of those vying for the Republican
nomination have also criticized regulations brought in after the
crisis, saying they would repeal the Dodd-Frank reform law.
In an interview with Reuters on Wednesday, Kashkari criticized
Dodd-Frank's so-called "living will" rule, which requires banks to
show how they can be dismantled in an orderly way if they fail,
without creating risk to the broader financial system. Kashkari said
he believes the rule would not work in a crisis scenario – that
banks would simply be bailed out again.
"I challenge anybody who thinks, in a stressed time, we would put
these banks through resolution," he said. "I really don't think it
will happen."
One way to force large financial firms to break up is to
"aggressively ratchet up" their capital or leverage requirements,
Kashkari said. He warned, though, that banks would likely fight hard
against any such proposal.
Indeed, Tony Fratto, who worked with Kashkari at the Treasury
Department and is now a bank lobbyist at Hamilton Place Strategies,
said his former colleague's comments were out of touch with reality.
"This is something like re-opening the barn door after the horse is
in the stable," Fratto said. "Love or hate Dodd-Frank, it's simply
blind to say that it hasn't significantly improved safety and
soundness."
OUT OF ARROWS
Securities analysts and consultants say that banks are in an
unenviable position because moves they might have made in the past
to improve profitability have been hindered by regulation. As a
result, they have struggled unsuccessfully for years to get their
returns on equity above single digits.
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"In some ways, banks have become bad utilities," said Fred Cannon, a
bank stock analyst with KBW. "With utilities, you have strict
regulation in what you can do and charge, but in the end investors
get a reasonable return. With banks, that last piece hasn't
happened."
Bank executives have long argued that weak returns are a "cyclical"
issue that should go away when markets begin to flourish again. But
as the industry approaches the eighth anniversary of the financial
crisis's nadir, questions about whether they face a secular rather
than a cyclical profit problem have only grown louder. And top
bankers are now wondering how they can possibly grow revenue under a
sprawling set of global financial regulations that limit what they
do, and sometimes conflict with one another.
(For a graphic showing bank earnings and share price performance,
see http://tmsnrt.rs/1mZb4h8)
One common example raised is how new capital rules can penalize
banks for being big but also discourage them from getting smaller.
For instance, due to their size, the eight largest U.S. banks must
collectively hold $200 billion in extra capital, which weighs on
shareholder returns. Included in the capital requirement is a fixed
amount each bank must hold to represent "operational risk."
Although the Fed does not explain exactly how it comes up with that
figure, it is not just a function of size: Bank of America Corp must
hold 25 percent more operational risk capital than JPMorgan Chase &
Co, the biggest bank in the country.
Bank of America has said it's taken steps to address the Fed's
concerns by cutting back on certain revenue-producing activities
that created operational risk. Nonetheless, the bank says it has so
far been unable to persuade the Fed to reduce that capital
requirement. Its shareholder returns suffer as a result, because
revenue is dropping faster than capital costs.
"Every bank is trying to figure out, with bigger capital
requirements and profit pressure, how can they create acceptable
returns for their shareholders," said John Weisel, an Ernst & Young
executive who advises global banks on business strategy.
After years of cost-cutting, he said, CEOs are asking themselves:
"We've used all the arrows in our quiver, so what are we going to do
next?"
BREAK-UP DEMANDS
European banks are behind their U.S. competitors in addressing a
more regulated environment and, in some cases, are flailing around
for answers.
Last week, Deutsche Bank shares hit an all-time low on worries that
it won't be able to buy back some bonds that can convert into
equity. Deutsche regained some value after it outlined plans to
repurchase $5.38 billion worth of other bonds, but investors'
concerns don't seem to have been entirely assuaged.
Meanwhile, Barclays has come under pressure after a Bernstein
analyst wrote an open letter on Feb. 5 imploring CEO Jes Staley to
break up the bank.
Rob McDonough, who advises financial institutions on risk management
at Angel Oak Consulting Group, says megabanks may have little choice
but to get significantly smaller.
"It's too expensive," he said, "for banks to be big."
(Additional reporting by Pamela Barbaglia, Sinead Cruise, Dan Freed
and David Henry; Writing by Lauren Tara LaCapra; Editing by Carmel
Crimmins and Martin Howell)
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