Bankers: Can’t live with ’em, can’t live without ’em.
That seems to be the sentiment of many government officials. Late last month President Barack Obama excoriated America’s top bankers for paying $18 billion in bonuses after a year of record losses, calling such behavior "shameful." On the very same day, European Central Bank president Jean-Claude Trichet criticized investors for demanding that banks hold more capital, saying such an attitude will stall lending and aggravate the recession.
Those comments reflect a deeper ambivalence. Everyone wants banks to help get the economy moving again — but without having them take excessive risks that could trigger fresh problems. Striking the right balance is a challenge for policymakers as they draft new regulations in response to the crisis.
Former Federal Reserve Board chairman Paul Volcker in a report for the Group of 30 last month called for tougher regulation — including curbs on proprietary trading and principal investing — for key institutions.
Massive losses at major banks have shown that giant financial conglomerates are "unmanageable," noted Volcker, who is advising President Obama on regulatory reform and will present his ideas to the administration this month. "The present system has been broken. It has failed the test of the market," Volcker said.
Regulators should consider broad restraints on risk-taking, contends Nouriel Roubini, an economics professor at New York University’s Stern School of Business and one of the first to predict that subprime mortgage problems would cause a wider financial panic. He thinks big institutions should be required to buy insurance for the risks they pose to the overall financial system. By pricing such insurance appropriately, regulators could discourage excessive risk-taking and defray the costs of future bailouts, he says.
There’s very little risk-taking going on at the moment, which is a major reason economies are tanking around the globe. But because the consequences of past failures are so glaring now, this is precisely the time to put permanent safeguards in place, regulatory reform advocates say. Otherwise, "once the crisis is over, banks are going to go and do reckless stuff," Roubini tells Institutional Investor .
The cost of past excesses continues to mount. The International Monetary Fund late last month raised its estimate of global credit losses from U.S.-originated toxic assets from $1.4 trillion to $2.2 trillion. The ultimate figure may be higher still. Roubini, whose forecasts have been remarkably accurate, in January raised his estimate of total credit losses at U.S. institutions alone to $3.6 trillion.
Financial industry executives attending the World Economic Forum in Davos, Switzerland, last month agreed that tighter regulation is inevitable, given the size of industry losses and the trillions of dollars in equity and guarantees that governments have provided to banks. "Regulation is coming, and it’s going to come in a very major way," Henry Kravis, co-founder of Kohlberg Kravis Roberts & Co., said at a panel discussion on the future of the financial services industry. "Will it go too far? It remains to be seen."
Some bankers are trying to get ahead of the curve, with calls for the industry to put its house in order. Stephen Green, chairman of London-based HSBC Holdings, thinks banks need to "recover a sense of what is appropriate" and focus more closely on client needs to regain their trust. "The business model will have to change," he says. "There will be less pure market-related risk, but not none, going forward. And the other side of that coin is a focus on real customer-generated business."
Tighter regulation and greater industry discipline will almost certainly mean lower margins for banks — once profitability is restored, that is. By using leverage to take bigger positions in structured products, major banks were able to generate returns on equity of 20 to 30 percent or more in the boom years of 2005 and 2006. But as Green said, "that model has gone, and I don’t think it’s going to come back." Banks will need to generate ROEs of about 15 percent to be able to raise capital at book value, a condition for the industry’s future health, contends Jes Staley, CEO of JPMorgan Asset Management. Hitting even that reduced target may be difficult, though. "Twelve percent is a good return," Nikolaus von Bomhard, CEO of Munich Re, tells II . "Banks will have a hard time meeting even that."
