Wall Street experts say regulation a drag on bank profit

Sweeping financial regulatory reform will reduce bank profits and could squeeze systemic risk from Wall Street into new corners of the market, a securities industry conference heard on Thursday.

The massive Dodd-Frank Bill, which could be signed into law as soon as Thursday, responds to the 2007-2009 financial crisis by setting tougher capital requirements, establishing a consumer protection watchdog and imposing new trading rules.

The nitty-gritty of the new law will not be known for many months, as rule-making duties shift to agencies like the Securities and Exchange Commission. But banks are bracing for the end of more than two decades of deregulation.

"In our view, it is back to the future. Moving forward profitability goes down, fees go down, leverage goes down and expenses go up," said Fred Cannon, chief investment strategist at KBW, a boutique investment bank specializing in banks and thrifts.

Policy analyst Jaret Seiberg of Concept Capital warned an overflowing audience of securities industry executives that fee income, such as checking account charges, will come under pressure by the new consumer protection agency.

"You can't assume the revenue streams of the past will exist," Seiberg told the Securities Industry and Financial Markets Association regulatory conference.

Growing customer fees and looser capital rules allowed banks to boost profitability even as net interest income from their balance sheets fell.

Analyst Kian Abouhossein, who leads JPMorgan bank stock coverage in London, sees investment bank profitability falling by 3 percentage points to about 16 percent. Changes to the Basel II bank capital rules could chop off 4 points from returns, he said.

"Investors generally demand 15 percent returns for investment banks, which tend to be volatile businesses. We think that is achievable," he said.

All three analysts concurred that other changes will offset these declines, including cuts in employee compensation, business reductions or passing on costs to customers.

What is harder to predict, the panel said, is the impact of efforts to prevent another systemic credit crisis.

"The goal of the bill is to push the risk out of the banks and to smaller entities who would not have systemic impact," Cannon said.

Abouhossein said hedge funds will be big winners, since Dodd-Frank will let them compete in new areas and most will not be subject to the new too-big-to-fail rules. He argued regulators should cast as wide a net as possible.

Customer-related securities trading, or "flow" trading, could be another area to suffer some unintended consequences, Abouhossein said, since a wide number of firms will be competing for the same business. The new bill attacks the practice of proprietary trading, or making bets with the bank's own money.

"We look at the revenue wallet, compare with the announcement of new staff and hiring targets and the numbers don't stack up," he said.

[Source: By Joseph A. Giannone, Reuters, New York, 15Jul10]

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