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The U.S. banking industry is in an upbeat mood as it looks ahead in 2018, following a year of policy and regulatory uncertainty under the Trump administration, including an announced changing of the guard at the Federal Reserve. Overall, the banking and finance sector performed well in 2017 — stocks have appreciated in the last 12 months — but the sector also suffered setbacks with reports of misdeeds by companies like Wells Fargo, while others, such as UBS and Deutsche Bank, received waivers on restrictions imposed on them after they pled guilty to currency manipulation in the LIBOR scandal of a few years ago.
In the year ahead, the banking sector will be bolstered by the fact that the Trump administration is favorably disposed towards Wall Street, and it will benefit from the latest tax reforms as U.S. corporations bring back profits held overseas. In addition, the new Fed chair, Jerome Powell, who takes over on February 3, is expected to continue raising rates and maintain the steady pace of his predecessor, Janet Yellen.
At the same time, lingering consumer distrust – a fallout from the recent scandals — and more competition from fintechs are potential hurdles for banks this year, according to Wharton legal studies and business ethics professors Peter Conti-Brown and David Zaring. Conti-Brown and Zaring discussed the outlook for the banking industry in 2018 on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
A ‘Lighter Touch’
An easing of regulatory scrutiny seems to be the most important gain banks are looking forward to in 2018. According to Zaring, the deregulation that banks expected in 2017 but didn’t materialize could become reality this year. “[A] lighter touch by regulators over banks may be beginning to happen,” he said.
Conti-Brown noted that amid much lobbying by the banking industry, the House of Representatives last year passed The Choice Act 2.0, the second version of the overhaul of the Dodd-Frank act that came into place as a response to the 2008 financial crisis. The Choice Act is still pending in the Senate. “But what we’ve seen in the Senate, too, is a dramatic proposal of some bipartisan buy-in to redo the way that we regulate big banks, but not the biggest banks,” he added, noting that banks are “cheering that move.” He also sensed “a lot of sympathy coming from the Trump treasury” on how banks and systemic risks are regulated.
“[A] lighter touch by regulators over banks may be beginning to happen.”–David Zaring
Conti-Brown didn’t expect a wholesale rollback of the main aspects of Dodd-Frank, such as consumer financial protection, regulation of derivatives, and the regulation of systemic risk as an alternative to bankruptcy in case of failure of large institutions. But the big change will be in how they are implemented, he said. “I think all of those big blocks are here to stay. How we do it, though, will be radically changed.”
Both Zaring and Conti-Brown expected relaxations in the Volcker Rule that prohibits banks from conducting specific investment activities on their own account. Smaller banks have complained about not being able to trade on their own account, said Zaring. Conti-Brown noted that “even [former Fed chair Paul] Volcker himself wasn’t pleased with the complexity of the implementation [of the rule] and these definitional exercises.”
“Wall Street has found a lot to like about Trump-era bank regulation,” said Zaring. However, he pointed out that the Trump administration has not exactly done much to help community banks so far. “It hasn’t been opposed to them, but certainly everything that they’ve done has been great for the really largest banks and not particularly great yet for community banks.” At the same time, the smaller banks would have reason to celebrate if the Volcker Rule goes away, he noted.
The Tax Cuts and Jobs Act of 2017 will also benefit banks greatly, said Zaring. Thanks to the incentives in that legislation, banks are expecting their corporate clients to bring back money held overseas — and that could find its way into M&A deals and fees for bankers, he explained.
“When clients don’t see risks and they just see low volatility, they need less from banks to structure their investment portfolio.”–Peter Conti-Brown
The flip side, according to Conti-Brown, is that an environment with lower risk and lower volatility means businesses would tap banks that much less for instruments to hedge their risks. “When clients don’t see risks and they just see low volatility, they need less from banks to structure their investment portfolio.”
Weaker Consumer Protection?
Zaring also expected consumer protection to take a backseat in the year ahead. “It definitely looks like in the current regulatory [environment] the people in place are less interested in that kind of a consumer protection mission than they might have been in the prior administration,” he said. “It is a little scary for consumers, because all of a sudden they’re going to feel like they’re on their own. One of the great things about America’s banking system is that you’ve generally – and I’m not saying that this is no longer the case – been able to trust that when you put your money into a bank, it’s going to be safe, it’s going to be protected by deposit insurance, and hopefully you’ve had a sense that your banker is working on your behalf. I think a lot of that confidence has been undone by the Wells Fargo scandal and the way banks and other financial intermediaries … have treated consumers.”
According to both experts, the Consumer Financial Protection Bureau (CFPB) is likely to see some dramatic changes. Conti-Brown noted that signs of that are already evident in the latest actions of Mick Mulvaney, budget director in the Trump administration who is also acting director of the CFPB. “He’s literally rewritten the CFPB mission on its website to say [that it’s job] isn’t so much about consumer financial protection; it’s about making markets competitive, which is consistent with what House Republicans have been asking for.”
Different Strokes at the Fed?
The likely path of the Federal Reserve is also a gray area that would merit a close watch, said Conti-Brown. He noted that there could be differences in approaches between Fed chair Powell and the central bank’s new vice chair of supervision, Randal Quarles. “Do you look to see what Randy Quarles is doing, or look to see what Jerome Powell is doing?” he asked. “Is there going to be any daylight between them? I think that’s going to be the palace intrigue at the Fed to watch as Randy Quarles asserts himself.”
Zaring also expected some stability under Powell. He said that from a macro perspective, it seems like “Powell is a ‘don’t-rock-the-boat’ appointment…. Powell is the one who’s most likely to keep things the way that they have been going under Yellen.”
“One of the great things about America’s banking system is that you’ve generally … been able to trust that when you put your money into a bank, it’s going to be safe.”–David Zaring
Conti-Brown expected “the fiercest arguments” to take place over moves to change the threshold for banks that qualify as “too big to fail” and therefore are subject to higher scrutiny and stress tests. He referred to moves to lift the threshold from $50 billion in assets to $250 billion, which would enable several big banks to be freed of higher scrutiny. “Is this going to just expose the entire system to greater risk and greater instability?” he asked.
Zaring and Conti-Brown also referred to the setback to consumer confidence levels resulting from the Wells Fargo scandal and the way Equifax managed its security breaches in the past year. “There is a silver lining to the cynicism that bank misbehavior can breed,” said Conti-Brown, “and that is … a young generation — an entrepreneurial generation — just saying, ‘Well, banks are terrible at this. We can do it better.’” He cited innovations such as a “lending club intermediary” that offers “an online only, no-ATM savings account at 3% interest.” He also saw the growth of fintechs and crypto currencies like bitcoin as a response to unmet banking needs. “That that cynicism feeds an entrepreneurial cycle that we’re seeing, and I expect we’ll see more of [it].”