BusinessDay 20 Jul 2017

Thursday 20 July 2017
Harvard
Business
Review
Global Business Perspectives
BUSINESS DAY
9
CONNECTING THE WORLD ONE BUSINESS AT A TIME
All-clear for big banks raises fears of a return to risk
The JPMor gan Chase bank branc h
It took a decade — and $200
billion in fines — but the big
banks are back.
The Federal Reserve’s
passing grade for all 34 of the
institutions it checks annually for financial
soundness, the first all-clear
since the Fed tests began in 2011, is
a watershed moment.
The immediate winners include
investors as well as bank executives,
who could see their already-ample
pay packages expand further. Even
as the broader market fell on July
6, bank stocks surged as investors
cheered the big dividend increases
announced by J.P. Morgan Chase,
Wells Fargo, Citigroup and others
following the Fed’s statement.
Looking out further, many big
institutions might have more flexibility
to lend, a major factor in
promoting the long-term growth of
businesses. At least in theory, the
greater capital that the banks now
hold and less stringent oversight of
the financial sector by Washington
could give the economy a shot in the
arm after years of caution.
“It’s not a sudden thing. It’s
been a long time coming,” said Guy
Moszkowski, managing partner at
Autonomous Research U.S., an independent
firm in New York. “But
American banks are more soundly
capitalized today than at any time
in my career, which started in 1979.”
On the other hand, critics fear
that the easing of regulatory pressure
and a more laissez-faire-oriented
White House could set the stage
for a return to the bad old days of
enormous leverage and freewheeling
deals until the music inevitably
stops.
“This isn’t the time to put the
brakes on regulation,” said Mark T.
Williams, a banking expert at Boston
University and a former bank
examiner for the Federal Reserve.
He noted that, with the 10 largest
American banks holding 80% of all
banking assets, “this concentrated
financial power residing at the top
banks should be carefully monitored.”
It was exactly 10 years ago this
July, as the housing bubble collapsed,
that the first cracks in the
country’s economic edifice appeared.
Within 18 months Bear
Stearns and Lehman Brothers were
gone, and once-invincible names
such as Citigroup and Bank of
America teetered on the edge, necessitating
a federal bailout.
The economic and psychological
scars of the financial crisis and the
ensuing recession linger, as do the
industry’s public-relations woes.
In terms of financial metrics
such as earnings, dividends for
shareholders and the ability to absorb
potential losses in the event of
a recession, however, the financial
sector clearly has turned a page.
The banks tested by the Fed now
have a $1.25 trillion capital cushion,
compared with less than half that in
2009.
In a July 5 statement, Michael
Corbat, chief executive of Citigroup,
said, “Today marks a significant
milestone for Citi and our shareholders.”
The Fed’s assessment, he
said, demonstrated that “Citi has
the ability to withstand a severe
economic scenario and remain well
capitalized, while also substantially
increasing our level of capital return.”
Although President Donald
Trump has promised to roll back
many of the rules imposed after
the financial crisis while appointing
regulators with a much lighter
touch, many bank analysts say that
memories of 2008 and the penalties
that followed nonetheless will inhibit
risk-taking in the future.
“Parts of the industry had a
near-death experience, while some
financial institutions actually had
a death experience,” Moszkowski
noted, adding that, as was the case
following the crash of 1929, “the legislative
and regulatory response was
quite harsh.”
“(The 2008 crisis) forced the U.S.
banking system to recognize its
losses and recapitalize itself quickly,”
Moszkowski said. “The lack of
that type of pressure in Europe has
contributed to what has been a longer
period of weakness and recovery
there.”
With European banks still hobbled,
American banks have benefited
in recent years, boosting their
share of global revenues from underwriting
and advice on mergers
and acquisitions.
Nearly a decade of historically
low interest rates, engineered by the
Fed, also has helped banks rebuild
their financial fortunes, even as savers
and investors watched the yields
on their money-market accounts
and certificates of deposit shrink.
“The banking industry has pretty
radically de-risked its balance
sheet,” said Chris Kotowski, a senior
research analyst at Oppenheimer.
For example, he said, in 2007
banks held more than $250 billion
dollars’ worth of corporate bonds
on their trading desks and other
accounts. By April 2017 that figure
stood at only a little more than $54
billion.
The current rate of delinquencies
on products such as credit cards and
commercial-real-estate loans is half
what it was during previous periods
of healthy economic growth,
Kotowski added.
At the same time, while banks
may have the ability to lend more
freely, anemic demand for credit
and slow economic growth are likely
to restrain new loan growth. The Fed
is only now in the process of slowly
raising interest rates in the face of
what policy-makers see as stronger
economic growth. If rates keep
moving up, higher borrowing costs
for businesses and consumers most
likely would offset whatever benefit
slightly easier credit from a healthier
banking system provides.
There are other shifts by big
banks, wrought by the financial crisis
and the long economic recovery
since then, that won’t be reversed.
After shedding tens of thousands
of workers and shuttering hundreds
of branches, the banking industry
isn’t about to go on a hiring or building
spree.
“Necessity is the mother of invention,
and banks have been
forced to operate more cheaply,”
Moszkowski said. “Changing customer
behavior, like use of mobile
banking, has also enabled them to
cut back on branches and staff.”
While bankers themselves might
be more cautious about lending or
about blurring the distinction between
traditional banking and Wall
Street-style trading, one element of
the go-go years has made a comeback
recently: big pay packages for
top executives. With the big rally in
bank stocks since the election in November,
the options packages and
other stock-based incentives that
bank executives received in recent
years have swollen in value.
“Executive compensation hasn’t
declined since the financial crisis,”
Williams said. “It’s gone up.”
In 2016 J.P. Morgan Chase chief
executive Jamie Dimon received
a total pay package of $28 million.
In 2006 his overall compensation
equaled $27 million.
For his part, Kotowski believes
that memories of Lehman, plus the
enormous fines paid to regulators,
will serve as a check on appetite for
risk for years to come.
“Even if bankers all started behaving
like drunken sailors tomorrow,”
Kotowski said, “it would take
years before problems arose.”
(Nelson D. Schwartz is an economics
writer for The New York
Times.)
2017 Harvard Business School Publishing Corp. Distributed by The New York Times Syndicate