Are Banking Regulations Already Backfiring?

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Global banking regulations put in place to combat “too big to fail” may already be backfiring.

The regulations would impose a sliding scale capital requirement on “systemically important financial institutions” — or Sifis. Last month, the G20’s Financial Stability Board identified banks whose failure it believes “would cause significant disruption to the wider financial system and economic activity.” These include JPMorgan Chase , Morgan Stanley , Goldman Sachs , Citigroup , Bank of America , and Wells Fargo .

Banks complained loudly about the designation—and, more so, the additional capital requirements. But as Rob Cox and Peter Thal Larson point out in a BreakingViews column, they may actually benefit from the designation as G-Sifis (short for G-20 designated Sifis).

Moreover, in the eyes of credit rating agencies and customers, banks with a G-Sifi label will be deemed stronger counterparties. In certain businesses, particularly foreign exchange, credit derivatives, cash management, transaction processing and even equity and fixed-income trading, this competitive edge could outweigh the cost of holding more capital.

Lower funding costs may also accompany the halo effect of being too big to fail.
That has certainly been the experience in the United States since the government stepped in to prop up the country’s biggest banks in 2008. Smaller U.S. banks pay almost 50 percent more than the top 100 lenders for deposits, the most stable form of funding, according to the Federal Deposit Insurance Corp’s most recent industry report.

Banks just below the G-Sifi radar may have to maintain even higher levels of capital in order to compete with their larger rivals for international business.

Some may even pursue acquisitions in order to improve their chances of being added to the G-Sifi list when it is next reviewed.

In other words, banks are preparing to use the Sifi designation as a marketing play. And from what I’m hearing from people at smaller Wall Street firms, Sifi is already becoming a code word for “ultra-safe counterparty” against whom minimal collateral requirements may be charged.

It will also lead to more consolidation. Banks that already receive the most stringent capital treatment face little disincentive to further expansion. Sure, the regulators say they might, someday, perhaps, maybe impose an even higher capital requirement if banks keep expanding. But everyone I speak with considers that highly unlikely. If you are JP Morgan Chase, might as well keep growing.

In short, it’s already not working out.

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