Last week, while at the gym near my office, I overheard two men talking, almost venting. “It’s over” they said with constant repetition. Normally, these words would have little meaning without the proper context, yet I knew exactly what they were talking about. I too have been saying this for quite some time, and with greater frequency in the last few months.
What these gentlemen were referring to, was the slow death of the Banking Industry. Many of the government regulations that were created in response to the financial crisis go into effect this year. So now Wall Street is bracing itself for the changes that are being hard-wired into this industry.
To date, banks have still been reporting profitability, but for the first time, revenues, which is the most basic indicator of an industry’s health, stood still. So in order to capture profits, banks have been aggressively cutting costs – including salaries and headcount. Entire divisions are being shut down and salaries have shrunk substantially – I for one am making far less money than I’ve made in previous years.
And this is just the beginning. A few weeks ago at an industry gathering, former Treasury Secretary Tim Geithner, acknowledged that impact of the government regulations will cut profitability of banking, roughly in half. And with the increase in capital requirements that banks must hold against each dollar of risk that they assume, the impact of these regulations will be severe.
But who cares about the fat cats on Wall Street, right? Well, you should care, because the health of banking system is critical to wellness of entire economy. And although these regulations will have a direct and immediate effect on institutional clients and investors, it will eventually trickle down to retail customers, like you and me. And here’s an example.
Banks will continue to seek profits and they will do so anyway they can. We have already seen this as interest rates on credit cards have skyrocketed to their all-time high; And this at a time when money is cheap and interest rates are near their 50-year low. I have even seen a credit card with an interest rate of 79.9% which is legal, as long as the credit card company properly discloses its terms.
So that is one implication on retail customers, but another segment that will be negatively impacted by these regulations is the small and mid-sized enterprises (SMEs). SMEs play a vital role in the economy because they account for over half of the non-farm GDP and attribute to over 60% of new job creation. But their inherent risk is high due to their failure rate. And with risk being a critical variable that banks use in their financing determination, banks will deem loans to this segment as too risky and subsequently too expensive for them to do.
I ran into a friend of mine, who is a long time Wall Street guy. We began to talk about the industry and I said that investment banking is dead. But he replied with great conviction “No it isn’t!” He then went on to state that investment banking is only dead at investment banks. But investment banking is very much alive and companies need financing more than ever. AND when there is a need, there is always someone who is looking to capitalize on that need. We are seeing this with “shadow banking.”
Shadow banking is a term used to describe the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks. These financial intermediaries facilitate the creation of credit across the global financial system, but they are not subject to regulatory oversight. And if you thought that fees charged by banks are high, try going to a shadow bank. And if that doesn’t work you can always go to your neighborhood loan shark – it may cost you two broken thumbs, but at least it will be cheaper than a bank.