In a speech at the Federal Reserve’s annual Jackson Hole symposium, Fed chair Janet Yellen reviewed the events leading up to the 2008-09 financial crisis and summarized post-financial-crisis regulations. She argued that the benefits of a stronger financial system outweigh the additional costs introduced by new regulation--a view with which we tend to agree. Furthermore, the need for broad post-crisis regulatory changes--including lower leverage, higher liquidity, regular stress testing, more stable funding, and reduction of counterparty risk--was indisputable after the near failure of the global financial system. Yellen acknowledged that regulation is a work in progress and seemed receptive to marginal changes, but her commentary threw cold water on hopes for a return to the laissez-faire approach of the early 2000s. We don’t expect major changes to the regulatory environment or bank profitability levels in the near term.
Though regulation has added costs and arguably depressed returns on equity in the banking sector, banks have also benefited. The fast and effective recapitalization of U.S. banks beginning in 2009 probably helped the country’s economy recover relatively quickly. New capital and liquidity requirements also reduced the cost of funding bank balance sheets; bank credit default swap spreads and borrowing costs are now a fraction of the levels reached at the height of the global financial crisis. This has undoubtedly boosted net interest margins.
Yellen highlighted two areas in which deregulation could be helpful. Credit standards remain very tight for low-end mortgage and small-business borrowers. The lack of credit availability in these areas seems to be a solvable problem, and one that would help bank profits as well as economic growth. Proposals affecting leverage or trading activity could receive the most coverage, but we’ll be paying the closest attention to moves that directly increase the availability of credit to marginal borrowers.
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