Trefis Team , Contributor
Last week, President Trump signed into law a partial rollback of the Dodd-Frank Act after the proposed changes cleared legislative hurdles in the Senate and the House. The Crapo bill dilutes some of the stringent regulations imposed by the Dodd-Frank Act on the U.S. financial system, and is primarily aimed at making things easier for small- and medium-sized U.S. banks, which were seen as being affected by the tougher rules in a disproportionate manner compared to their larger rivals.
But the bill did have things to offer to some of the largest U.S. banks – especially the two U.S. custody banking giants, BNY Mellon and State Street. Based on the changes proposed by the new bill, and using our interactive dashboards for BNY Mellon and State Street, we expect these two banks to return more cash to investors in the near future, as their profits improve marginally over coming years. As this will increase net margins and reduce outstanding shares for the banks going forward, this implies a small upside to these banks’ valuations.
A Quick Summary Of The Changes Implemented By The Bill Aimed At Banks
The Crapo Bill, formally signed as the Economic Growth, Regulatory Relief, and Consumer Protection Act, introduces changes on several aspects of the U.S. financial industry. The following is a summary of changes that target the bank holding companies:
Increase In SIFI Threshold
• Current regulations label all banks with more than $50 billion in assets as systemically important financial institutions, and subject them to higher regulatory scrutiny, in addition to stricter capital requirements. The bill increases the SIFI threshold to $100 billion, and will raise the threshold further to $250 billion after 18 months.
• Which Banks Are Affected? The Federal Reserve Board currently includes 38 banks with assets worth more than $50 billion in its rigorous annual stress tests. This figure will fall to just 12 given the new threshold, as nearly all regional banks will now be exempt from stricter regulatory oversight. Notably, investment banking giants Goldman Sachs and Morgan Stanley will not get any respite because of their identification as Global SIFIs by the Basel Committee
• Why Does This Matter? While the banks with $100 billion to $250 billion in assets are not completely off the hook (and will be subjected to stress tests periodically), they will save millions in regulatory compliance costs linked with the stricter scrutiny.
Boost To Supplementary Leverage Ratio Figure of Custody Banks
• Current regulations require banks to leave out any deposits they have with central banks of developed nations (like the Fed and the ECB among others) while calculating their supplementary leverage ratio. Overall, this requirement has a negative impact on this key ratio figure. However, the new bill allows only the custody banks to include these deposits in their calculation of supplementary leverage ratio – resulting in an immediate boost to this figure
• Which Banks Are Affected? This change is a welcome one for BNY Mellon, State Street and Northern Trust. Despite being the third- and fourth-largest custody banks in the world, JPMorgan and Citigroup will not benefit from this change because of their diversified business models (with significant investment banking exposure).
• Why Does This Matter? BNY Mellon and State Street have regularly fared among the best at the Fed’s annual stress tests in terms of impact of a severely adverse economic conditions on their profits and capital ratio figures. As their capital ratio figures are already very strong, the relaxed leverage ratio requirements should free up considerable amount of cash for these custody banks – allowing them to return a sizable chunk to shareholders through dividends and share repurchases in the near future.
Change In Treatment Of Certain Municipal Obligations
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• The current classification of securities held by banks does not allow U.S. Municipal Securities to be included as a part of high-quality liquid assets. The bill makes these securities admissible as a level 2B liquid asset (which can be included as a part of the Tier 2 capital ratio figure, with a haircut of 25-50%) provided they are investment grade and are marketable.
• Which Banks Are Affected? As all banks hold some proportion of municipal securities, this move is likely to have a positive (albeit small) impact on all U.S. banks
• Why Does This Matter? Banks with a sizable portfolio of eligible U.S. municipal securities on their balance sheets should be able to report a small uptick in their capital ratio figures thanks to this amendment. Clearly, the positive impact will be more for banks with a larger proportion of these securities.
These charts were made using our interactive dashboard platform, which is used by CFOs and Finance teams, private equity professionals and more to build interactive models and create, share and present scenario analyses.
Image not mine, source not known. From internet