Could Trump spark another financial crisis?

US bankers are still celebrating Donald Trump’s US election victory, anticipating less regulation and a wave of mergers and acquisition activity.

Bank stocks have risen an average 10 per cent since last month’s vote, while regional banks – likely to be the centre of mergers and acquisitions (M&A) – are up by nearly 11.5 per cent.

Donald Trump can remake the leadership of all the agencies responsible for regulating banks except the Federal Reserve.Credit: Bloomberg

JPMorgan Chase’s Jamie Dimon has said bankers are “dancing in the streets” at the prospect of a deregulatory Trump administration replacing a Biden administration that added layers of regulation and cast a pall over takeover activity. In the past four years bank M&A activity has been at historically low levels.

With the leadership of almost all the regulatory agencies overseeing banks changing, with the notable exception of the chair of the Federal Reserve Board, Jerome Powell, the bankers expect a wave of deregulation covering everything from capital requirements to consumer protections.

A key issue for the bankers has been the Biden administration’s efforts to impose tougher capital requirements on their banks in conformance with the so-called “Basel Endgame”, or the extra global capital requirements that would be added to the existing capital adequacy regime. Basel III would complete the series of prudential reforms that were a response to the 2008 financial crisis.

US banks have been fighting those proposed rule changes with a massive campaign that included roadside billboards, television advertisements and intense lobbying of politicians.

They have already had some success. The Fed’s vice chairman responsible for supervising the banks, Michael Barr, had originally proposed increasing the capital requirements for US banks by 19 per cent, which would have added about $US180 billion ($282 billion) to the capital requirements of the six largest US banks.

In September, that was cut to 9 per cent, requirements related to operational risk, mortgages and some other assets were reduced and banks with less than $US250 billion of assets were excluded from most of the new rules.

It is estimated that the backdown by the Fed will shrink the amount of extra capital required by the biggest US banks by about $US100 billion and Wall Street banks are now very hopeful that Trump’s new team will ensure even that reduced requirement disappears.

The US banks aren’t alone in questioning whether Basel III tilts the balance between institutional stability and risk-taking too far towards risk-aversion, with other jurisdictions like the European Union and Britain stretching out the timelines for its introduction and questioning some of the rules.

But the US banks are more likely to seek not just the withdrawal of what’s left of the Basel III changes, but a deeper and wider rollback of regulation, as occurred during Trump’s last term as president, when he unwound some of the post-2008 Dodd-Frank reforms to the sector.

JPMorgan Chase chief executive Jamie Dimon says US banks are “dancing in the streets” after Trump’s election win. Credit: Bloomberg

Barack Obama signed the Dodd-Frank Act into law in 2010, which imposed much stricter regulations on banks with more than $US50 billion of assets and annual “stress tests” on systemically important institutions, along with capital adequacy and minimum liquidity rules.

In 2018, Trump scrapped the $US50 billion threshold, created a new $US250 billion threshold that applied to only a dozen or so of the largest banks and weakened some of the regulations in the Act.

It is unclear whether those changes played a role in the collapses and bailouts of three regional US banks in March last year, including Silicon Valley Bank, which had more than $US200 billion of assets, although less regular and less intrusive supervision may have played a role in the bank failures.

However, there is a direct correlation between the level of prudential standards and risk. The more capital and access to liquidity a bank has the less risky it is and the less risk that taxpayers will have to bail out failed institutions, as occurred around the world after the 2008 financial crisis.

Too much capital and costly liquidity, however, and banks will ration their lending and the supply of credit to the businesses that drive economic growth and/or increase the cost of that credit.

There’s a fine balance between banks holding too much and too little capital. For banks deemed globally or domestically of systemic importance – too big to be allowed to fail – regulators should err on the side of caution.

One doubts caution will be the watchword for Trump’s new regulators. That will have implications for not only the US banking and financial system but the global system, given big US banks compete internationally and the level at which their prudential requirements are set will influence the competitiveness, or otherwise, of banks in other jurisdictions.

While memories of 2008 and its traumatic and costly aftermath may be receding, the last thing the global economy needs is competition between national bank regulators to lower prudential standards.

The US was hit by massive bank failures years after Trump loosened regulations. Credit: AP

Three key agencies regulate US banks: the Fed, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation. The US Securities and Exchange Commission and US Treasury also have roles in some bank-related issues.

In the background (well, actually front and centre), of course, are Elon Musk and Vivek Ramaswamy, their “Department of Government Efficiency” and their plan to slash government spending and red tape and cut a swathe through government agencies in pursuit of $US2 trillion of savings.

Cutting deeply into bank and other financial institution regulations to free up lending and boost bank profitability and economic growth would no doubt appeal to both, and Trump.

Trump can remake the leadership of all the agencies responsible for regulating banks except the Fed, where Powell’s term as chair (but not his board membership) expires in May 2026.

Powell has said he will refuse to relinquish the chair if asked by Trump.

Trump, who has made no secret of his desire to influence the Fed’s decision-making and explored mechanisms for sacking Powell during his last term (and discovered there wasn’t a legal basis for doing so), said last weekend that he wouldn’t ask him to resign.

Trump’s Republican advisers, however, have their eyes set on a different key Fed official, vice chairman Barr. While his term doesn’t end until July 2026, he might be more susceptible to pressure than Powell.

One doubts that caution is going to be the watchword for Trump’s new regulators.

Powell has allowed the vice chair for banking supervision almost total autonomy during his period as chair. Trump nominee Richard Claridawas allowed the authority to relax the Dodd-Frank regulations during Trump’s previous stint in the White House. Removing Barr and putting a pro-deregulation nominee in place would clear the way for deeper deregulation.

Another element of regulation that has some bankers excited is the potential for changes that would remove the additional capital requirements for holding some alternative assets, either directly or within individual customer accounts.

Assets like cryptocurrencies, private credit, private equity and structured securities that turn illiquid assets into tradeable assets could find their way into the mainstream banking system.

Given Trump’s newfound love of crypto and his ownership of a crypto platform, it would surprise no one if he decided to loosen bank rules to boost the US presence in the space.

The last time the US banking system was heavily engaged in structured and exotic products was in the years leading up to the 2008 financial crisis. Remember sub-prime mortgages?

Crypto wasn’t a thing back then and private credit and private equity didn’t loom anywhere near as large, but what’s the saying about history not repeating, but rhyming?

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.