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A Trump-induced euphoria for banks? Not so fast

Globe and Mail reporter Tim Kiladze.

Less than two weeks left of this tyranny. Then we'll be free from the socialists, the overreaching regulators, the long arm of government.

That's the subtext to the euphoria on Wall Street and in the American banking sector since Donald Trump was elected president. The KBW Regional Bank Index, which tracks 50 U.S. banks, is up an astonishing 27 per cent since Nov. 8. With the inauguration approaching, investors are assuming a Republican-led Congress will free banks from the shackles imposed by U.S. President Barack Obama and other policy makers after the 2008 financial crisis.

Some Canadian bankers have caught the mood, including executives at the helm of banks with sizable U.S. operations. At a conference this week, Royal Bank of Canada chief executive Dave McKay referred to Team Trump as a "pro-growth administration," adding that its policies should boost the lender's earnings.

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"Pro-growth." It's a term Mr. Trump used during the campaign, and it's caught on now that he's about to assume power. There are other variations, and they all suggest, without explicitly saying so, that the Obama administration is anti-growth – or, if you read Breitbart News, dominated by Russian-style socialists.

But exactly how tight are the financial industry's shackles – and exactly how much better could things get for bankers under Mr. Trump?

Mr. Trump hasn't said much about his specific plans yet, but House Republicans tabled a bill last summer that serves as a benchmark. Their main focus so far is replacing The Dodd-Frank Act. They want to scrap the Volcker Rule, which bans banks from proprietary trading, or making trading bets with their own money. They hope to prevent the Financial Stability Oversight Council from being able to label any non-banks as "systemically important," because the title can force companies such as insurers to hold more capital, and restructure the Consumer Financial Protection Bureau to take back some of its powers.

Has the litany of new regulations placed on banks since the Great Recession been burdensome? Absolutely. Canadian banks suffer from new domestic and global rules, too. The piles of paperwork and risk-testing now required every quarter is extraordinarily costly, and produces so much disclosure that investors can get lost in it.

But many of these rules were brought in following a global financial crisis spurred by irresponsible lending. Reworking the whole system again probably isn't necessary, and brings its own problems.

Some Republicans appreciate this. To prevent banks from being reckless, one group has suggested enforcing a more stringent, but simple, leverage ratio, which forces lenders to hold capital worth at least 10 per cent of their total assets. The current rules require 5 per cent.

Rather than forcing banks to hold different amounts of capital depending on the risk profile of each asset, a leverage ratio is a hard-and-fast rule. (It's a bit like a carbon tax: Instead of imposing scores of complex rules about fuel efficiency and energy conservation, you put in place one simple rule – a price on carbon – and let the market have its say.)

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But even a simple rule has consequences. Analyst Jason Goldberg at Barclays PLC calculates JPMorgan Chase & Co. would need $107-billion (U.S.) more equity, or more than 40 per cent over its current level, to meet the proposed leverage ratio. If raising capital is too tricky, banks could sell off assets or shrink their balance sheets – which could starve the economy of some lending oxygen.

Then there is the matter of where the United States is in the economic cycle.

The average expansion phase of a U.S. business cycle in the postwar economy has lasted 58 months, according to the National Bureau of Economic Research in the United States. It's now been 91 months since the bottom of the most recent recession in 2009. If history is any guide, a recession is likely some time in the next few years. That will hurt the banks.

It's true the current expansion isn't like most. U.S. consumers kept trimming their debts during the early years of the recovery, so growth has been much more tepid, averaging just 2.1 per cent during the expansion. The U.S. economy is gathering some steam. Unemployment has fallen below 5 per cent and wages are rising. The Federal Reserve is hiking interest rates. That's usually a precursor to the end of the cycle and a recession.

Investors aren't completely off-base with their optimism about banks. Elements of Mr. Trump's proposed agenda, such as infrastructure spending, should accelerate economic growth in the short term. And reforming the United States' arcane tax code should give banks some tax relief, which flows directly to their bottom line.

Some proposals, though, could come back to haunt the banks longer-term. Like that old saying, there's no such thing as a free lunch.

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About the Author
Reporter and Streetwise columnist

Tim Kiladze is a business reporter with The Globe and Mail. Before crossing over to journalism, he worked in equity capital markets at National Bank Financial and in fixed-income sales and trading at RBC Dominion Securities. Tim graduated from Columbia University's Graduate School of Journalism and also earned a Bachelor in Commerce in finance from McGill University. More

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