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Banks’ profits may get squeezed

Global leaders seek new limits on risk

By Simon Kennedy and Christine Harper
Bloomberg News / September 21, 2009

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NEW YORK - Global leaders meet this week seeking to deliver the broadest financial regulation overhaul since the 1930s, potentially threatening profits and stock prices of banks, from Goldman Sachs Group Inc. to Barclays PLC.

President Obama and his Group of 20 counterparts convene in Pittsburgh Thursday and Friday to cement a plan to force banks to curb leverage, hold more equity capital, and keep a greater pool of assets that can be easily traded.

Bankers’ pay will also top the agenda as officials try to hammer out an accord that would prevent a repeat of the worst financial crisis since the Great Depression.

But by limiting the ability of banks to invest and trade, the world’s governments could check this year’s 22 percent gain in the Standard & Poor’s 500 Financial Index. That may be a price they’re willing to pay to prevent a repeat of the risk-taking that sparked the collapse of Lehman Brothers Holdings Inc. a year ago, a worldwide recession, and taxpayer-funded bank rescues.

“Regulation will make banks less profitable by increasing the cost of doing business,’’ said Andrew Clare, a professor at Cass Business School in London and a former Bank of England official. “If banks are going to benefit from taxpayer largesse then they need to act in a way that doesn’t hurt taxpayers or the economy.’’

The summit, which will also be attended by Prime Minister Gordon Brown of Britain, President Nicolas Sarkozy of France, and President Hu Jintao of China, will also discuss how to sustain the economic recovery, avoid protectionism, improve accountancy, and revamp governance of the International Monetary Fund.

Leaders travel to the Steel City amid voter disquiet after governments used public money to bail out banks, only to see many of them quickly return to profit and resume setting aside billions for bonuses. A Gallup poll in June showed that 59 percent of Americans wanted action to curb executive pay.

Under consideration: forcing banks to augment their capital buffers to better account for risk, retain more earnings, and satisfy a leverage ratio which measures equity as a proportion of total holdings. They may also consider a proposal to tie pay to capital levels.

“There has been a culture that rewards short-term thinking, that used leverage to take exorbitant risks that were unsustainable for the system as a whole,’’ Obama said on Sept. 14. “That’s the culture I think that we’ve got to reverse.’’

A crackdown could lower profitability by a third at Goldman, Barclays, and Deutsche Bank AG’s investment bank, JPMorgan Chase & Co., analysts led by Kian Abouhossein said in a Sept. 9 report.

Deutsche Bank’s return on equity will probably tumble the most among the world’s largest investment banks, falling to 6.7 percent in 2011 from 10 percent today, the analysts said. Goldman’s return on equity will probably decline by 4.4 percentage points, and Barclays’ by 4.3 points.

Spokespeople for Goldman, Deutsche and Barclays declined to comment.

Investors may suffer if financial companies have to issue more equity, said Charles Goodhart, a professor at the London School of Economics.

“Banks will have to raise more capital by issuing more equity, so existing stocks will generally go down,’’ Goodhart said. The IMF estimated in April that US and European banks would need $875 billion in extra capital.

But Goldman has demonstrated that higher capital and lower leverage don’t always mean reduced profits. The company still set a Wall Street profit record this year, making $3.4 billion on $13.8 billion of revenue in the three months that ended in June.

Since the demise of Lehman, some banks have already cut leverage, boosted capital by selling stock, and set aside a larger pool of easy-to-sell, or “liquid,’’ assets.

German Chancellor Angela Merkel and Sarkozy have campaigned for the G-20 to focus on bonuses, arguing excessive executive pay played a role in triggering the crisis.

The risk for politicians trying to persuade voters they haven’t let bankers off the hook is that the financial industry eventually finds a way around the regulatory revamp.

“We aren’t doing anything significant so far, and the banks are pushing back,’’ said Nobel laureate Joseph Stiglitz, a professor at Columbia University. “The leaders of the G-20 will make some small steps forward, given the power of the banks’’ and “any step forward is a move in the right direction.’’