People always expected large banks to complain when new regulations
hit the wires because they had been at the center of the "too big
to fail" debate and the primary target for the regulator. Surprisingly
though, it is the small banks that are in the news now. The Wall Street
that these same small banks that did so well during the crisis are
having serious profitability issues now, calling this effect "too
small to succeed."
Funnily enough, they pointed to the new regulations designed to make
banks smaller. They said that the cost of regulatory compliance was
way out of their budget. Some said well how much do small banks matter,
who really needs them? Well it turns out there are over 5,400 "small"
banks in the US with assets under $1bn. That's 5 trillion dollars!
So the Federal Reserve Bank of Minneapolis, one of the 12 branches of
the US Central Bank, conducted a study
in 2013 to delve into this issue and puts some numbers to all the talk.
The conclusion is decisive: there is no cost-effective way for small
banks to adopt new regulations. Whether hiring staff, re-focusing
existing staff, external consultants, building or buying new IT systems
for a "non-revenue" function weighs heavily on the profitability of
banks at the smaller end of the spectrum (Assets<$50mn), with a single
new hire decreasing the overall Return on Assets by up to 0.23%.
This may not sound like a lot, but 0.23% is HUGE, when you consider
that the Fed Funds Rate
is 0.09%. To make matters worse, the Fed supposed that firms at the
larger end of the spectrum (Assets close to $1bn) will have higher
costs and hire more staff resulting in even greater impact on profitability.
Looking at the Minneapolis Fed's findings below, we see that this puts
374 banks below the minimum profitability threshold of 0.4%!
This has astounding implications because it demonstrates that banks
throughout the spectrum are feeling the pain of new regulations on
their profitability. If we extrapolate the costs incurred to larger
banks we seem some interesting results:
Large banks like JP Morgan ($2,500bn of Assets) will need hundreds of
new employees (or IT expenses) to deal with new regulations. A recent
highlights Deutsche Bank's EUR 1bn effort for regulatory concerns with
over 1,300 dedicated staff. 1,300 employees that do nothing for the
banks profitability! In the Fed's study, a new regulatory expert would
command a salary of $70k in rural areas and $90k in urban. At a large,
systemically important bank, a regulatory expert might make $100-250k
depending on bank size. This means a bank with $500bn in assets
(ex. Danske Bank/Bank of Nova Scotia) will be spending a minimum of
$50mn to implement new regulations. Sure, it is only 0.01% of total
assets. But if we consider the $223tr of worldwide assets, then that
is a minimum of $22.3bn in additional annual operational costs
globally that should be avoidable. We are looking forward to this challenge.
- Suade Labs (September 2014)
Update! A friend showed me this OECD Working Paper
that put the total cost at 5-15bps (which is roughly $100bn globally).
So basically, it's kind of a big deal.