European banks expecting good things following President Trump’s steps to row back regulation could be disappointed
Stock markets have been especially kind to banks since the Trump election, and last week’s announcement of an executive order to reduce financial regulation added a further boost. But regulatory relief will be slow in coming and may not be as much as markets seem to expect. And for European banks, the net effect is likely to be that they fall even further behind their US counterparts.
The Trump approach to financial regulatory reform is as chaotic as everything else. In the past year, he has said he wants to dismantle Dodd-Frank, to break up the banks, and to restore Glass-Steagall. He has also said he supported the Financial Choice Act, for which Congressional hearings will soon begin. But, on February 3 he took a different (or an additional) approach by issuing an executive order to establish “core principles” of financial regulation, which include remaining tough on the banks, but eliminating ineffective regulation and that not vetted by rigorous cost-benefit analysis.
That’s been enough to get markets thinking that Dodd-Frank will be defanged, new regulations (and litigation) will be halted, rules limiting proprietary trading and derivatives will be loosened, and the whole compliance process will be made less cumbersome, costly and time consuming. For the first time in years, all but one of the six leading US capital market banks are trading above book value (Citigroup is still at 78% of book). One analyst recently predicted that these banks will have $100 billion more to distribute to shareholders through dividends or buybacks because of regulatory relief.
Others, experts in Congressional and regulatory procedure, say not to hold your breath.
The revived effort by Jeb Hensarling, chair of the House Financial Services Committee, to enact his Financial Choice Act that substantially amends Dodd-Frank and provides an opt-out from it, will require 60 votes in the Senate that Republicans don’t have.
Further, Trump’s heralded executive order, which aims to reduce the burden of the 400 new rules that Dodd-Frank required regulatory agencies to issue, is at least two years from any significant impact. Rule changes are bound by administrative procedure and are subject to public comment and legal challenge in the courts. In any case, it takes time to sift through all the Dodd-Frank rules and all the others on the books, as the executive order requires, and to figure out what to do about them.
How much relief this might provide large banks is unclear. Most of the regulatory weight of financial reform since the 2008 crisis is concentrated in the much-tightened Basel III minimum capital requirements, which Trump will not abandon, and in the qualitative stress tests conducted by the still independent Federal Reserve.
Still, most observers believe that the US regulatory burden will not increase, starting from now, and is likely to be reduced over time by the Trump government, though the amount of benefit this will produce may be less than the markets now assume.
But any relief is better than none, and will free up funds with which banks can compete for market share and for shareholder investment with their shrinking number of European rivals.
More important than regulatory relief to the banks, however, is the positive market sentiment that expectation of Trump economic policies has brought. Higher US growth rates, more capital investment, more mergers and larger project financings than would have occurred under a Hillary Clinton government, and certainly more than can be expected in an EU split by political divisions and still stuck in a low growth mode.
The three remaining European capital market banks (Barclays, Deutsche Bank and Credit Suisse) have benefitted from the Trump rally too, but still lag their American competitors. Credit Suisse now trades at 68% of book value, up from 44% in the summer; Barclays is at 58%, up from 34%, and Deutsche Bank, is only at 37% of book, up from a miserable 23% last September.
None of these banks can expect much from US regulatory easement, and instead, are stuck with adapting to a gloomy European political and economic outlook, Brexit, ringfencing, balance sheet and income statement problems, and continuing worries about US litigation for misselling mortgaged-backed securities, money laundering and sanction-breeching, which led to Deutsche Bank’s full page apology to shareholders last week for another massive loss.
American banks will likely assume that the improving economy and the expectation of regulatory relief that has driven up their stock prices removes the pressure on them for any sort of strategic realignment – that is, to separate themselves into two businesses, commercial banking and investment banking, rather than continue to try to operate both under one roof. It is doubtful that this strategy is correct, especially for Citigroup and Bank of America, but the sharp rise in their stock prices has kept this wolf from their doors, at least for now.
European banks, on the other hand, continue under pressure from the market to split up or back away from capital market activity which has proven so difficult for them to master. More positive developments from the US will widen the gap between US and European capital market banks. But the Europeans still in the game believe they have little choice but to remain in it. At least for now.