G20 to overhaul financial regulation
Leaders' agenda threatens bank profits and stock prices
September 22, 2009
By Simon Kennedy and Christine Harper Paris and 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 to Barclays.
President Barack Obama and his Group of 20 (G20) counterparts convene in Pittsburgh on 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.
Restraining bankers' pay and narrowing imbalances in trade and savings will also feature on the agenda as officials try to hammer out an accord to prevent a repeat of the economic crisis and ensure a sustained recovery.
By limiting the scope of banks to invest and trade, governments may check this year's 22 percent gain in the Standard & Poor's 500 financial index. That may be a price they are willing to pay to prevent a repeat of the risk-taking that sparked the collapse of Lehman Brothers 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. "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 UK Prime Minister Gordon Brown, French President Nicolas Sarkozy and Chinese President Hu Jintao, will debate how to drive the recovery, avoid protectionism, improve accountancy and revamp governance of the International Monetary Fund (IMF).
The officials will also try to devise a framework to generate a more balanced world economy through greater US savings, European investment and Chinese domestic demand.
Leaders travel to the Steel City amid voter disquiet after governments used public money to bail out banks, only to see many of them return to profit and resume setting aside billions for bonuses.
In a YouGov poll this month, 73 percent of UK voters wanted a tax on all bonuses over £10 000 (about R120 000). A Gallup poll in June showed that 59 percent of Americans wanted action to curb executive pay.
Under consideration is 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. The G20 may also consider a proposal to tie pay to capital levels from Financial Stability Board chairman Mario Draghi.
"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 last week. "That's the culture I think that we've got to reverse."
The crackdown could lower profitability by a third at Goldman Sachs, Barclays and Deutsche Bank's investment bank, JPMorgan Chase analysts said in a report.
Deutsche Bank's return on equity would probably tumble the most among the largest investment banks, falling to 6.7 percent in 2011 from 10 percent now, the analysts said. Goldman Sachs's return would decline by 4.4 percentage points and Barclays' by 4.3 points.
"The amendments to capital requirements will clearly affect the activities of banks in their trading books and securitisations," said Alessandra Mongiardino, an analyst at Moody's Investors Service.
Spokespeople for Goldman Sachs, Deutsche Bank and Barclays declined to comment.
Investors might suffer if financial companies had 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 (R6.54 trillion) in extra capital.
Goldman Sachs has demonstrated that higher capital and lower leverage do not always mean reduced profits. The company, which set aside a record $11.4bn for compensation and benefits in the first half, cut its ratio of assets to common equity to 16 times in the second quarter from 26 times a year earlier. It still set a new Wall Street profit record, making $3.4bn on $13.8bn of revenue in the second quarter.
The new rules will probably also take years to go into effect, with US Treasury Secretary Timothy Geithner proposing that new capital requirements be in place by the end of 2012.
Since the demise of Lehman, some banks have already cut leverage, boosted capital by selling stock and set aside a larger pool of liquid assets.
"Banks have already changed so substantially that it's unlikely the G20 can impose a further pinch in terms of beefing up liquidity or reducing leverage," said Simon Gleeson, a lawyer at Clifford Chance in London. - Bloomberg
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