Europe on edge as Trump embarks on a highwire banking act

As Trump gets set to chart a delicate course on financial regulation, European banks are in a very vulnerable position.

Brokers are pictured at the stock exchange in Frankfurt, Germany, on November 9, 2016 after the outcome of the presidential elections in the US. (AFP PHOTO/DANIEL ROLAND)

The prospect that the incoming Trump administration will wind back the 2010 US response to the financial crisis, the sprawling Dodd-Frank Act that placed layers of new regulation on US banks, adds pressure to the already-fragile global consensus on post-crisis banking reforms.

US bank stocks were up more than 10 per cent last week at the prospect of massive debt-funded infrastructure investment and lower taxes boosting the US economy and lifting US interest rates, but also because of Trump’s platform of deregulation of the banks and demolishing the Dodd-Frank Act in particular.

After the crisis, which forced large-scale US taxpayer bailouts and financial support for its banking and financial services sector, the Dodd-Frank Act covered almost every aspect of US banking system, from capital requirements to prohibitions on principal trading to consumer protections. It was 2,300 pages of re-regulation.

Trump is on record as saying he would repeal the Act, saying it had left bankers petrified of regulators and resulted in banks being unwilling to lend, slowing US economic growth and undermining its competitiveness. It either had to be “got rid of” or made smaller.

While there is some confusion about the details of Trump’s plans for bank regulation (as there is with many of his policies in the immediate aftermath of the election), it appears that, at the least, much of the regulation will be rolled back.

The changes could include the “Volker Rule” that prohibits principal trading and the threshold for banks designated “too big to fail” and subject to more stringent regulatory standards might be raised quite significantly.

There have been Republican suggestions that the threshold for being deemed a “systemically important financial institution” in the US, which triggers more stringent capital requirements and regulatory oversight, should be lifted from $US50 billion of assets to $US250bn of assets.

The thrust of the commentary from Trump and the Republican Party on banks has been in favour of deregulation but they have also canvassed the possibility of a 21st century version of the 1933 Glass-Steagall law that required the separation of commercial and investment banking in the US and whose abolition in 1999 is blamed by some for laying the foundations for the crisis.

The new administration will need to chart a delicate course between being seen as soft on Wall St, which wouldn’t go down well with the Trump support base, while reducing regulation and encouraging banks, particularly the smaller banks, to lend more.

The Trump scepticism about the nature and unintended consequences of post-crisis banking regulation in the US — and of the US Federal Reserve Board’s monetary policies — mirrors the mounting criticism of the last planned tranche of global banking reforms in Europe, where banks and national policymakers complain of the implications for their banks and economies.

The final phase of the Basel III post-crisis reforms, generally referred to as Basel IV, which are aimed at producing a more standardised approach to risk-weightings of both credit and conduct risk — and which could lead to a requirement for banks to hold even more capital than the earlier Basel Committee reforms to the minimum capital levels required — is scheduled to be unveiled before the end of this year. The plan is for them to be in place by 2018.

Thirteen of Europe’s biggest banks, those deemed “too big to fail” also face having to raise “total loss-absorbing” debt that would be first in line for loss in the event of bank stress under a European Commission proposal that would come into effect in 2022.

European banks and their national regulators are pushing back against both Basel IV and the European Commission plan.

A sector that Credit Suisse chief executive Tidjane Thiam recently described as “not really investible” because it was not generating profits sufficient to cover its cost of capital could be required to raise as much as €850 billion of new capital if Basel IV is introduced.

Negative interest rates (and a much less decisive response to the crisis than the US) have undermined the European banks’ profitability and stability and make it very difficult for them to even consider raising the equity and debt envisaged by the regulators if the proposals are introduced.

The election of Trump on an anti-globalisation platform and his apparent support for some level of deregulation of the US financial services sector will make the Europeans even more nervous about reforms that, because Europe has far less developed capital markets than the US, will impact its banks far more significantly than it would US banks.

In the wake of the Brexit vote, which has very significant implications for the future of London as a world financial centre, the Europeans will also be leery about the combination of Trump’s “America first” rhetoric and proposals that could boost US banks and their international competitiveness even as their own are suffocated by the combination of weak growth, the European Central Bank’s negative interest rates and still-rising capital and liquidity requirements.

With Trump’s economic plan likely to inject enormous stimulus into the US economy and push up inflation and US interest rates faster than had previously been anticipated (which, perversely, is good for bank profits) the US banking and finance system, including its financial markets, might well grow to some extent at Europe’s expense.

That does, of course, treat Trump’s still-vague approach to banking reforms in isolation from his promised protectionist approach to trade and globalisation more broadly, which could have very sinister implications for banks and their financial systems everywhere, including the system in the US.