New Regulations' Effects On US Banking Profitability

This morning's Wall Street Journal featured an article in the Money & Investing section contending that proposed new financial regulations could, by mandating 'plain-vanilla' financial products, such as mortgages and credit cards, result in a reduction in bank profitability.

I think the article's premise is correct. Having worked in one of the nation's large, money-center banks, Chase Manhattan, for years, I can attest to the truth that the more complex, illiquid and/or non-standardized financial products are, the higher their profit margins tend to be.

That's why bond and derivative trading are nice businesses. Without centralized clearing and settlement and/or transparent price quotes, margins stay high. Especially on retail customer transactions.

In product lines like credit cards and mortgages, various fees and the all-important credit card balance-maintaining customers drive the above-bank-average profitability of these businesses.

However, I don't see anything wrong with this particular type of regulatory reform, nor its effects on bank profits.

I've contended for some time that financial services business growth, over time, can't legitimately exceed that of the economy. Financial services is a purely derivative activity. It's done to facilitate other activities, not for its own reward.

Therefore, in order to 'goose' growth and profits, bankers routinely develop new products with extra fees or complexities which allow premium pricing, at least for a while. After seeing how many people failed to understand, or claimed to fail to understand their mortgage documents during the recent mortgage lending problems, it may well be a good idea to mandate simpler, plain 30-year, fixed-rate home loans be available as a default choice for consumers. The same could well be true for credit cards, which also seem prone to misuse and abuse by under- or uneducated consumers.

If these proposed regulations retard bank profit growth or margins, so be it. Better to have a healthier, slower-growing financial services sector with fewer catastrophic losses than what we've seen out of mediocre bank management for the past half-decade.