Sky-high bank profits boost the case for borrowing restrictions in finance

With enough leverage, you can move the world.
With enough leverage, you can move the world.
Image: Reuters/Romeo Ranoco
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Another day, another stellar earnings report from a big Wall Street bank. This time, it’s Bank of America that beat the analysts with $4 billion in profits last quarter, a 63% increase from the previous year.

That follows big earnings from Goldman Sachs, JP Morgan Chase, Wells Fargo and Citigroup, which has raised the question: Is it time for banks to stop complaining about regulation? They’ve clearly found a way to remain prosperous while living in a brave new world of centrally-cleared derivatives, higher capital requirements and less proprietary trading.

Banks that complained about the deadening impact on the economy of the new rules don’t have much to stand on at this point. Their best complaint is about meager bumps in their number of compliance employees. The average financial institution apparently now needs 2.3 full-time employees to help comply with new rules, up from 1.06 the year before.

These results are quite a turnaround from a few months ago, when equity analysts at major banks were looking at one another’s businesses and shaking their heads at how regulation cost them return-on-equity. Some shareholders were starting to speculate that banks could be more valuable if split into different businesses, something many advocates of banking reform wanted in the first place. The problem the analysts identified wasn’t new capital requirements banks complained about, however, but the limitations imposed by regulators on what kind of business they could do.

Perhaps banks are simply mastering the next wave of regulatory arbitrage, which some argue makes their business model. Chances are, if banks were incorrect about how much regulation would hurt their business, so are regulators who think they’ve done enough to make the system less risky.

Here’s one indication: Much of the profit at these banks came from trading, not lending, which signals that their business model hasn’t changed. And the reason those trades were so profitable is likely because the money being traded was borrowed. That’s reflected in leverage ratios, a topic that neither Goldman Sachs nor JP Morgan wanted to touch on in their respective conference calls. On top of the Basel III capital requirements that came out of the financial crisis, US regulators are now planning new rules requiring leverage ratios of 5%—as in $5 in equity funding for every $100 in total assets—for holding companies and 6% at insured subsidiaries. While many of the banks report they are at or nearly at the 5% ratio for their holding companies, their subsidiaries are behind—perhaps $40 to $50 billion behind in the case of JP Morgan, the most profitable bank this quarter.

That’s a lot of financial ground to gain for the biggest banks. This week’s earnings should serve as fuel for regulators looking to implement new rules and speed de-leveraging along.