By Valentin A. Araneta
The Trump administration has initiated a review of the banking regulations in the US through an Executive Order with a view to “liberalizing” it from the stringent capital and prudential requirements imposed by the policy reforms established after the Global Financial Crisis(GFC). These reforms are encapsulated in the Dodd – Frank Wall Street Reform and Consumer Protection Act of 2010. The professed objective of this policy direction is to enable the banking institutions to make more credit available to the US economy and to make them more competitive with their competitors from other countries. However, it is important to appreciate the reasons for the reforms contained in the Dodd-Frank Act before these are reformed again.
The biggest participants in the US banking system commonly referred to as Wall Street which includes foreign owned banks are widely believed to have taken excessive risks resulting in the debacle of the mortgage backed securities that led to the GFC. Investors lost their life savings, workers lost jobs, the country and the world economy went into recession and taxpayers’ money had to be put in into the country’s financial institutions because if they collapsed, an even greater systemic disaster would have engulfed the economy. In October of 2008, The Troubled Asset Relief Program (TARP) of the US authorized the amount of US$700 billion of government funds to be infused in financial institutions or to purchase assets to keep these institutions viable and liquid. A total of US$426 billion was utilized and US$444 billion was eventually recovered and the US government came out ahead by US$12 billion.
However, the principal point behind the reforms imposed as a result of this crisis was that the crisis could have been much worse, the TARP and other measures undertaken by the Central Bank and other authorities might not have been enough and the taxpayers’ money could have been lost forever. Therefore, the Dodd Frank Act is intended to enhance the risk management and prudential controls of financial institutions, clearly delineating the accountabilities and responsibilities of governing boards and management and closely monitoring their compliance to the regulations. Strong safeguards against “ too big to fail” situations are written in into the law and the rules and regulations to prevent financial institutions from putting the government into a situation of having no choice but to bail them out of their problems because their failure would result into a much bigger systemic disaster. This is why the capital requirements of the financial institutions were increased, with even higher requirements for the more systematically important ones. Liquidity requirements have been increased and risk taking activities curtailed.
The results of the reforms in the US financial system appear to have had positive results for the biggest US banks. Their profitability and market performance are now among the best globally. The stock market capitalization of the biggest US banks are the biggest in the world. The current price earnings ratio, the ratio of the stock market price per share over the earnings per share of the current financial year which measures the confidence of investors of a company’s earnings performance are respectable. The ratio of the stock market price over the book value of the companies, which shows the confidence of investors in the future earnings performance of the company, shows on the average a higher valuation than their European counterparts. Therefore, the review of the existing laws, rules and regulations covering the US Financial System and particularly the Dodd-Frank Act should be done with an abundance of caution and very judiciously. The financial institutions are doing well inspite of the built-in safeguards for stability. They also seem to be on the trajectory for doing better. In the table below, the market capitalization, the P/E and Price to Book ratios of the top five US banks are shown together with the biggest banks from select countries of Europe. These indicate or show that the US banks have much bigger market capitalization with the capability to compete globally without a need for a loosening of the regulatory requirement to which they are currently subjected.
The opinions expressed here at the views of the writer and do not necessarily reflect the views and opinions of FINEX. You may email Mr. Araneta at firstname.lastname@example.org
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