The Associated Press reported today that the Federal Reserve will uncover financial overhaul regulations this summer, as indicated by a primed testimony from its Chairman, Ben Bernanke, to the Senate Banking Committee. The regulations are aimed at preventing arecurrence offinancial turmoil in the U.S. and restoring public confidence.
Following the approval of financial reform in 2010, the Fed was instructed by the Congress to frame the regulations. Now, the Fed and other regulators will update the Congress about their efforts to execute the financial overhaul successfully.
The rules will primarily focus on stricter regulatory capital and cash requirements for major banks, hedge funds and insurance companies, which could put the economy at stake in case of a failure. The banks under consideration include big names like JPMorgan Chase & Co. (JPM), The Goldman Sachs Group Inc. (GS), Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C).
Though the average U.S. bank fell short of the mandatory capital level following the recession, they have been raising billions of dollars through the issuance of equity and deployed capital more gingerly than ever before. This is exactly what the regulators want — to raise caution and knock down the possibility of another financial crisis.
What we shall get this summer is only a preview of the regulations to be put to practice in January 2012. Before the final implementation, the Federal Reserve will seek feedback from the concerned institutions and American citizens.
Looking back to last year, regulatory officials from more than two dozen countries came up with a new set of capital standards known as Basel III for the global banking community. According to Bernanke, learning from the past experiences, global regulators are trying to clip the major financial companies’ means to indulge in risky activities.
The Congressional Oversight Panel of the Troubled Asset Relief Program believes that the unclear goals of the program led to the perception that some institutions are “too big to fail.” What ensued as a result of the lack of articulation was a frightfully wrong idea that the Federal Reserve will always protect these institutions from failing, should they face a major financial danger.
Quite obviously, if the big institutions get the impression that a big shot will be there to save them whenever they are in dire straits, they will never hesitate to take extravagant risks. Unfortunately, taxpayers will have to bear the brunt if these institutions lose the gamble.
The onus now falls on the impending regulations to prepare the big institutions for any future deficiency and make them immune to financial crisis. But most importantly, big institutions should not have the perception that they would get taxpayers’ assistance in future if they dig their own hole.
To Conclude
The economic benefits of financial reform regulations and standards like Basel III are indisputable, as these would rebuild the weak capital level that threatens the economy. The norms could ultimately translate to fewer bank failures and less involvement of taxpayers’ money for bailing out troubled financial institutions.
Regulators and bankers are bound to disagree over the magnitude of positive impact the new rules will have as there remain other lingering concerns, including a high unemployment rate, persisting residential and commercial real estate loan defaults and liquidity challenges. However, over a longer period of time, financial institutions, which run with lower capital ratios, will be forced to maintain a required capital standard, which should provide buoyancy to the economy.
However, the financial reform regulations will compel the financial system to go through massive deleveraging, and banks in particular will have lower leverage in the near term. For the banks then, the implication is that their profitability metrics (like returns on equity and return on assets) will decrease.
BANK OF AMER CP (BAC): Free Stock Analysis Report
CITIGROUP INC (C): Free Stock Analysis Report
GOLDMAN SACHS (GS): Free Stock Analysis Report
JPMORGAN CHASE (JPM): Free Stock Analysis Report
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