Have you read Leo Tolstoy’s War & Peace? It’s a weighty tome. Now imagine reading it 15 times.
That’s how long the Dodd-Frank banking oversight document that was introduced in the aftermath of the Great Recession is. And that has Henry McVey, head of global macro and asset allocation at private-equity firm KKR, questioning whether regulatory burdens are too much for their intended goals.
This benefits firms like KKR, according to McVey:
“Our bottom line: If traditional financial intermediaries are going to struggle to earn a respectable net interest margin amidst increasing regulatory pressures, then there is a high likelihood that more and more complex transactions move off market.”
Banks have shed four to five trillion dollars worth of assets since 2010 amid more oversight and higher capital charges, according to estimates by Morgan Stanley. To put things into perspective, that’s akin to to four or more firms the size of Morgan Stanley leaving the industry, McVey wrote.
The top 10 investment banks in the US and Europe have also paid $150 billion in fines from 2009 to 2015, with the majority of that from failures in customer reporting. Compliance issues such as rigging foreign exchange rates and money laundering have wiped out 14% of total bank equity during that period, according to the report.
Banks have built over $100 billion in common equity from 2012 to 2015, according to McVey, largely as a result of stress tests. That has eroded banks’ return on equity by 100 basis points between 2012 and 2015, McVey wrote.
Now, on one hand, you might think that this is only right. The banking system should be safer. Banks should be fined for their misdemeanors.
But this also poses a challenge to the economy, and there is a feeling that post-crisis regulation has gone too far. If banks are no longer profitable, especially in a period where negative yields abound, then they’re less likely to support the economy.
Here’s McVey again:
“This migration might be good for investors, though we think it will continue to create ongoing profitability issues for the traditional global financial services system. This insight is important because financial services companies not only provide the required credit creation to fuel economic growth, but they also represent a significant portion of the global capital markets (both market capitalization and EPS).”